529 College Fund/Tax Implications questions - Help needed!

[Homerboy]

Let me set the table a little here:

My son has two 529 plans. One is in his grandpa's name and he is the beneficiary. The other is in his name.
He is currently in his third year of college, but we have not cashed out the 529s to pay for anything yet as since he has been in school, the loans he has have had 0% interest running on them. But that interest forbearance is coming to an end on Jan 1 2023 so we want to get these cashed out and loans paid down.

We have two types of loans for my son's education:
1) he has federal loans in his name (subsidized and unsubsidized)
2) I took out Parents Plus loan in my name to pay for the remaining balances

What we'd like to do now is to get these 529s cashed out ASAP before interest kicks in and (this is the important part) to use those funds to pay the Parents Plus loans first and foremost.
But the trick is that the money will be dispersed directly to him. So how do we go about using that money to pay down the loans in my name and not incur tax penalties come tax time in 2023?

I'm not sure what (if any) other information anyone will need, but I will be happy to share what I can.

Thank you for any insight you can provide.

 

[NutBucket]

So dumb question, why can't he just pay the loan directly? Why does he have to give the money to you?

 

[Homerboy]

So dumb question, why can't he just pay the loan directly? Why does he have to give the money to you?

Well, that's (part of) my question.
If he gets the cash from the 529, then he pays my Parent Plus loan which is in my name and not his, does that have tax implications for either of us?

 

[Dirigible]

Can A 529 Be Used To Pay Student Loans? Yes, And Here's How.

You can use a 529 plan to repay up to $10,000 in student loans - but there are some caveats you need to know.

thecollegeinvestor.com

Looks to me like $10k per borrower is tax free. So it is possible that $10k of the kid's loans and $10k of parent plus loans, for a total of $20k, to be tax free. That's lifetime, not per year.

Also looks like you do NOT want to give him the 529 cash and have him give that to you for the parent plus loans. Instead, looks like you'll need to have him as 529 beneficiary for the money withdrawn for his loans, the parent the 529 beneficiary for the withdrawals for the parent plus loans. "The account owner can change the beneficiary to a parent and use this to pay off up to $10,000 of parent education loans too."

That all could be oversimplified or wrong, but that's how I read it.

 

[Homerboy]

Can A 529 Be Used To Pay Student Loans? Yes, And Here's How.

You can use a 529 plan to repay up to $10,000 in student loans - but there are some caveats you need to know.

thecollegeinvestor.com

Looks to me like $10k per borrower is tax free. So it is possible that $10k of the kid's loans and $10k of parent plus loans, for a total of $20k, to be tax free. That's lifetime, not per year.

Also looks like you do NOT want to give him the 529 cash and have him give that to you for the parent plus loans. Instead, looks like you'll need to have him as 529 beneficiary for the money withdrawn for his loans, the parent the 529 beneficiary for the withdrawals for the parent plus loans. "The account owner can change the beneficiary to a parent and use this to pay off up to $10,000 of parent education loans too."

That all could be oversimplified or wrong, but that's how I read it.

Ok - truth be told this was more or less my understanding, but I wanted some fresh opinions without me planting a seed of thought.
Basically, what needs to be done then is to have him (since he's an adult) convert me to the beneficiary on the 529 account(s) directly. Then the funds will go directly to me, and in turn I can pay off the PP loans in my name without tax penalty.

 

[Dirigible]

Yeah. I don't fully understand why the restrictions on using 529s for student loans exist, but they definitely make things a bit trickier than when directly paying school costs.

 

[dullard]

Yeah. I don't fully understand why the restrictions on using 529s for student loans exist, but they definitely make things a bit trickier than when directly paying school costs.

Paying off loans is the opposite of the intention of 529 accounts. A 529 is intended as an education savings plan for future education spending--not current spending or even past education spending. The 529 plan was intended to augment prepaid future tuition plans and education saving trusts that were common at the time. Using the 529 to pay off loans is certainly legal, but it flies in the face of the intent of the origins of the 529 plan. If states and/or congress want to make paying off parent student loans easier, that is something that they could certainly do. But they haven't.

For example, if a parent of a current college student has lets say $10k now, the 529 plan intention is to have the parent pay that $10k towards education purposes. The 529 plan intention is NOT to put that $10k into a 529, get tax credits, get tax protected investment savings, and then get a $10k loan for the student's education expenses, only to be paid off after years of tax-protected investments.

 

[Dirigible]

Thanks dullard. I enjoy your posts. They tend to be well-thought-out and clear. This is no exception.

 

[purbeast0]

As someone who started two 529b's this past year, what was the point of taking out a loan if you had a (2 of em) 529b for your son to pay for his tuition up front?

 

[Homerboy]

As someone who started two 529b's this past year, what was the point of taking out a loan if you had a (2 of em) 529b for your son to pay for his tuition up front?

interest rates have been frozen for 2.5 years. Take the loan(s) interest free and let the 529s still go up (though now they have gone down)

 

[purbeast0]

interest rates have been frozen for 2.5 years. Take the loan(s) interest free and let the 529s still go up (though now they have gone down)

Yeah I can see that but as @dullard that isn't really the intention of what a 529b was for so I'm not surprised it's not straight forward to pay off the loans with it.

 

[deadlyapp]

Yeah I can see that but as @dullard that isn't really the intention of what a 529b was for so I'm not surprised it's not straight forward to pay off the loans with it.

Tax hacks.

Same reason why I have friends who took out student loans years ago (although they had cash to pay for their tuition) and invested the cash well enough to pay off the loans immediately upon leaving college as well as enough extra to buy a house. Can't really do that in this market but this was in the early 00s.