529's and Student Loans

[sengsational]

Today a supplement to the 529 'Fact Kit' was announced for the Fidelity "UNIQUE College Investing Plan".

A notable addition was in the "Purpose of Expense" section. Before, they had sections for:

• Higher Education Expenses
• Elementary and Secondary Education Expenses

The supplement has two more sections:

• Apprenticeships
• Student Loan Repayment

It's that last one that caught me off-guard because, as far as I recall, student loans "didn't count". In other words, paying student loans didn't allow you to pull from your 529 account penalty free (unlike QHEE).

Here are some excerpts:

Student Loan Repayment - amounts paid as principal or interest on any qualified education loan (as defined in section 221(d) of the Code) of
a 529 plan designated beneficiary or a sibling of the designated beneficiary. The amount treated as a qualified expense is subject to a lifetime limit of $10,000 per individual. This provision is effective for such distributions
made after December 31, 2018. Any federal income tax deduction otherwise available for interest on any qualified education loan will be reduced by the interest component of any qualified withdrawal used to repay a qualified education loan of the applicable taxpayer in the applicable tax year

And from the FAQ:

want to use the money to repay student loans? You may pay amounts used as principal or interest on any qualified education loan of a 529 plan designated beneficiary or a sibling of the designated beneficiary up to a $10,000 lifetime limit per individual.

I'm just reporting what I saw just now. I have no idea where or when this tax law change happened. I just wonder how this got past me! The change must have been in some Federal legislation that got passed, or I suppose a court case could have had this as a consequence.

Did anyone know that this rule change happened 'a long time ago'?

 

[sengsational]

Ok, I found out that the law was signed into law on December 20, 2019.

https://www.congress.gov/116/bills/hr1865/BILLS-116hr1865enr.pdf

Now my question is about student loan payments made in 2019 without aligned 529 account withdrawals. So, say you paid your normal monthly student loan payments in 2019 and took no 529 withdrawals. Can you now add-up those monthly payments and pull an amount equal to those payments out of your 529 (this year, 2020) without penalty?

The Fidelity 529 experts are back Monday. I guess I'll wait and call then.

 

[sengsational]

This is looking like the answer is going to be "no":

https://studentloansherpa.com/secure-act-2019/

Word of Warning

When requesting reimbursement, be sure to do so in the same calendar year during which the educational expense or loan payment occurred. If you make a loan payment on December 28, you will have to hurry to request the reimbursement before January 1 of the following year.
This also means that you cannot contribute money into your 529 account to reimburse yourself for a loan that has already been repaid in the past. That said, the new paragraph (c) makes these changes retroactive from January 1, 2019. Talk to your state’s 529 plan administrator or a CPA specializing in 529 plans for individual advice.

 

[SecondCor521]

Ok, I found out that the law was signed into law on December 20, 2019.

https://www.congress.gov/116/bills/hr1865/BILLS-116hr1865enr.pdf

Now my question is about student loan payments made in 2019 without aligned 529 account withdrawals. So, say you paid your normal monthly student loan payments in 2019 and took no 529 withdrawals. Can you now add-up those monthly payments and pull an amount equal to those payments out of your 529 (this year, 2020) without penalty?

The Fidelity 529 experts are back Monday. I guess I'll wait and call then.

I disagree with the studentloansherpa website and think that the answer is "Yes, as long as you properly coordinate any such withdrawal with the student loan interest deduction as required by the new law in Section 302(b)(2)."

There is a conservative viewpoint out there that all 529 transactions must take place in the same calendar year as the expenses. However, my understanding is that the IRS has never issued regulations requiring that. I also don't see that restriction anywhere in Pub 970 nor in the text of the law you quoted above. The section you're looking for is Section 302 of Division 0 of PL116; I think it is pretty understandable to read.

 

[sengsational]

^^^ Thanks for that input. I didn't want to believe it either, but it's on the Internet...it must be true

I do recall the earlier discussions (in past years) and different perspectives on whether the 529 distributions had to be in the same year as the QHEEs. My recollection was that the IRS was leaving that fuzzy. So that means (to me), the IRS hasn't taken anyone to court over it (or we'd know one way or the other, I suppose).

So if we presume that student loan payments are 'just another QHEE, bro', then the earlier treatment should hold for this new type of expense, and thus be allowed to match-up with a distribution in a later year.

On Monday, I'm calling Fidelity, but I don't hold out a lot of hope that they'll come down squarely on one side or the other; they might just bail with a 'consult your tax attorney'. I'll report back.

 

[SecondCor521]

So if we presume that student loan payments are 'just another QHEE, bro', then the earlier treatment should hold for this new type of expense, and thus be allowed to match-up with a distribution in a later year.

On Monday, I'm calling Fidelity, but I don't hold out a lot of hope that they'll come down squarely on one side or the other; they might just bail with a 'consult your tax attorney'. I'll report back.

That's what the law says (well, without the "bro").

I agree with your logic.

I agree with you that Fidelity won't give you tax advice.

 

[sengsational]

I agree with you that Fidelity won't give you tax advice.

Got quickly through to someone at the Fidelity "529 department" who seemed to completely understand my question immediately (given a withdrawal taken now in the amount equal to student loan payments made in 2019, will that trigger a penalty or trigger tax liability on the gains).

Got the answer I expected, but not the one I wished for; the reps there can't do anything that would be considered 'interpretation' of the IRS rules, so the bottom line was "consult your tax professional". I mentioned that for a decade, I've read differing opinions about matching 529 withdrawals with earlier year HQEEs and haven't heard of anyone getting thrown in the clink. There was a small chuckle, then the rep said something I took to mean that it's the same 'problem' as it's always been with the timing of spending with withdrawals. I take that to mean the IRS hasn't clarified this (probably because the law passed doesn't specify it). I'm not curious enough to dig any farther.

If I decide to take the money out equal to the 2019 student loan payments, even if there is penalty and tax due, it wouldn't cost me very much money. But I like to be squarely on the proper side of things, which is why I usually do some digging before taking action.

 

[sengsational]

Decided Not to Pull Funds Anyway

I decided not to pull the 2019 student loan amount from the 529. Not because it was the previous tax year, but because keeping the student loan write off is a better deal.

Say you payed $850 in interest in 2019, and you're in the 22% marginal tax bracket. That's worth $187 in tax savings. Then if you're in a state with a 6% marginal tax bracket (and your state doesn't make you add-back the student loan interest), that's worth another $51. So it would cost you $238 in lost tax savings to get the money out from under the 529. It depends on where you are in your payoff schedule, but say your payments were 25% interest and 75% principle. You're giving up 7% (238/3400) in order to get the money out. That cost is better than the penalty plus tax on the gain, but there's no cost at all if used for QHEE's in the future.