529 Plan Funds Won’t Pay Your Student Loans

One of the many expenses parents take into consideration when raising children is the future cost of sending that child to college. Various savings options allow families to begin a nest egg for that very endeavor. The government, in cooperation with investment firms, developed the high yielding 529-college savings plan. While the plan provides substantial growth and returns (5% or more annually), the option also contains many drawbacks…one of which is that 529 plan funds don’t pay for student loans.

Expenses Covered Under 529 Plans

Contributions and earnings from 529 plans are only tax exempt when used for qualified higher education expenses or QHEE. Specifically, these expenses include books, equipment, mandatory fees, supplies and tuition. The plans also cover room and board, as long as the child enrolls at a minimum of a ½-time student, and under certain circumstances, there may be a cap on housing allowances.

The money may also pay for the expenses of special needs students. The money cannot be used for paying off student loans or for any other purpose, including food, personal expenses or travel, otherwise plan owners must pay federal and state income tax in addition to a 10% penalty on earnings.

Non-covered 529 Plan Costs

While the monies from 529 plans are transferable from state to state, certain schools in states may be ineligible for these funds. Parents having a 529 plan in Wisconsin can use the money for college in Florida. Though most schools qualify, some do not.

In addition to possible taxation for improperly used money from 529 plans, the accounts are subject to application fees, management fees and annual maintenance fees, that in total, range from $300 to $2000. These charges vary with individual states and with the type of plan acquired.

One might argue that student loans are for money that paid for the expenses that 529 plans do cover. Unfortunately, the law does not see it that way. Student loan payments and the interest attached to them is not covered by a 529 plan. This means that parents need to carefully consider which costs they take loans for and which they pay for with 529 plan funds.

Parents considering a 529 plan must either begin the account early enough in the child’s life in order to pay for college from the start of enrollment, or have a backup plan to accommodate student loans and other non-school related expenses. The Coverdell Education Savings Account has similar restrictions, the difference being that until the end of 2010, individuals were also allowed to use the monies for K-12 educations.

How to Get the Most out of Both

The smartest thing to do is to create a list of college expenses that your child will incur. Then pull out those that will be covered under your 529 plan. If the plan has enough to cover all of these costs, great! You can simply pay the non-covered costs by loan, savings or other investments you have set aside for your child’s education. If not, the balance of education expenses should be lumped with the costs not covered by the 529 plan and addressed through whatever means you have set up for these costs. Just don’t get caught with a large 529 account and a school loan when you can’t use those funds to pay the loan. See what you can pay with the 529 account first and then dip into loans if you must.