529s and student loan repayment - 529s & Student Loan Repayment

529s and student loans

Question: I have a 529 fund for my daughter. she graduated in May. In the process of her going to school we went ahead and took out school loans. There is enough money in the 529 fund to pay the loans off. It seems to me since the funds are going to pay off an education fund there should not be any tax issues but the fund management company says paying of the school loans is not a an "approved" use of the funds. They are right that is is not "listed" on the approved list but it is paying off college loans by definition the loan was for school and went toward tuition etc. I have checked with several accountants no one seems to give me a straight answer. Eric, Grand Island, NE

Answer: I'm taking your question because it highlights a common pitfall. Student loans are not listed as one of the Qualified Higher Education Expenses for a tax free withdrawal from a 529 college savings plan. The list usually includes tuition, fees, books, and supplies and equipment needed to attend a college. For instance, a personal computer is considered a qualified expense. Room and board counts for students who are enrolled at least half-time, although there are some restrictions. Student loans aren't on the list. I don't make up the rules.

Two quick thoughts: Your daughter can use the money for graduate school if she has plans to attend one in the future. The account owner can also change the beneficiary of the plan. The restriction is that the new beneficiary must be a member of the family of the old beneficiary. Here is how the IRS defines family: The beneficiary's family includes the beneficiary's spouse and the following other relatives: Son, daughter, stepchild, foster child, adopted child, or a descendant of any of them; brother, sister, stepbrother, or stepsister; father or mother or ancestor of either; stepfather or stepmother; son or daughter of a brother or sister; brother or sister of father or mother; son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law; the spouse of any individual listed above; and first cousin.

I've recommended these web site before, but two good sources of information on 529s are savingforcollege.com and finaid.org.

08/10/09 by Chris Farrell