Can I use a 529 plan to pay a refinanced student loan?

Question

As pointed out in another question, in the U.S. we can now use a Qualified Tuition Program (QTP, e.g. a Section 529 Plan) to pay student loans as a qualified education expense - provided your state also allows this, which mine does. The newly released IRS Publication 970 for the 2019 tax year provides some good information, but it glosses over certain details. I even called the IRS and tried to ask for clarification, and the rep admitted that she couldn't find any answers because it's still too new. I'll periodically try to get the IRS to conjure up an official answer, but I'm hoping that someone can either shoot holes in my interpretation or provide additional support for it being valid.

My other question about tax deductions is only tangentally related, so I'll focus in this question on refinanced/consolidated student loans.

From the 2019 Publication 970, in Chapter 4 on the Student Loan Interest Deduction:

Interest on refinanced and consolidated student loans.
This includes interest on a loan used solely to refinance a qualified student loan of the same borrower. It also includes a single consolidation loan used solely to refinance two or more qualified student loans of the same borrower.
If you refinance a qualified student loan for more than your original loan and you use the additional amount for any purpose other than qualified education expenses, you can't deduct any interest paid on the refinanced loan.

So interest paid on refinanced or consolidated student loans still qualifies for the Student Loan Interest Deduction. That seems straightforward enough. But the implication seems to be that a refinanced or consolidated student loan is in turn still considered to be a student loan if it meets the qualifications (only used to pay for student loans and qualified education expenses for the same borrower). This should mean that a Qualified Tuition Plan can, presumably, also be used to pay for such refinanced/consolidated student loan payments (up to the lifetime limit of $10,000 per borrower). The publication doesn't explicitly describe this, but the implication seems like a natural fit with the intention of what is explicitly stated.

So does this mean that I can find any (reputable) bank willing to offer a good enough interest rate and loan term to consolidate my student loans, save money each month with a lower payment, save money long term in less interest, and still be able to use the new Section 529 Plan expansion to proxy (part of) these payments and enjoy all relevant tax deductions related to student loan payments?

Perhaps more specifically, should I expect to pay tax penalties on the Section 529 plan withdrawals for payments on a student loan refinance and consolidation loan? Or is my reasoning solid for saying that this should count as a qualified education expense?

Edit: The IRS phone reps flatly refuse to clarify this or even to ask a supervisor for clarification. So unless they update documents, the answer is “take your best shot and hope you aren’t wrong.”

Answer 1

Short answer: yes, you can use a 529 plan to pay for refinanced student loans. As long as a loan is eligible for the student loan interest deduction it is also eligible to be payed out of the 529.

Long answer:

Refinanced student loans (bar some exceptions) are considered "Qualified Student Loans" just like the original loans were. This is described in the quote you provided. Now look at Chapter 8, on the 6th bullet point on page 58 it states:

distributions made from QTPs after 2018, no more than $10,000 paid as principal or interest on qualified student loans ... [emphasis mine]

Since Chapter 4 is the only place where "qualified student loans" is defined, this seems to imply that as long as the loan is "qualified" (going off of the Chapter 4 definition), you can use a 529 to pay it.

To be even more clear you can go to the actual House Bill for the new 529 rules, which states:

(A) IN GENERAL.—Any reference in this subsection to the term ‘qualified higher education expense’ shall include a reference to amounts paid as principal or interest on any qualified education loan (as defined in section 221(d)) of the designated beneficiary or a sibling of the designated beneficiary. [emphasis mine]

Section 221 of the U.S. code discusses interest on education loans (specifically for the interest deduction), and states:

The term “qualified education loan” means any indebtedness incurred by the taxpayer solely to pay qualified higher education expenses ... [emphasis mine]

This would arguably include refinanced loans, which matches the IRS Pub.

Note that you cannot use 529 funds to pay interest on a loan and then also take the loan interest deduction (double dipping - page 35 of the IRS Pub).