Transfer 529 Funds from Child's Account to Pay Parent's Existing Student Loans?

Question

We have been saving a little every month into our daughter's 529 account since she was born. She is now 10 years old, and the account balance is about $25,000. We intend to continue to make regular deposits into this account for another 10 years.

I (dad) still owe about $2,400 in student loans.

Does the 2019 SECURE Act allow me to (1) change the beneficiary from my daughter to me on this 529 account, (2) use the account to pay off my existing student loans, (3) change the account beneficiary back to my daughter - without any federal tax penalties? (I'm in California, so there are no state tax considerations.)

Answer 1

Each state sets the rules regarding the state tax impact of 529 contributions and usage.

from the scholarshare529 Plan Details & Information

California State Income Tax Information

In addition to federal tax benefits, there are state tax benefits as well. For California taxpayers, tax treatment is as follows:

While contributions are not deductible for California income tax purposes, earnings accrue free of state income tax. Any withdrawals used for qualified higher education expenses and outgoing rollovers to other qualified 529 plans and 529A ABLE accounts are also state income tax free.

Withdrawals for tuition expenses at a public, private or religious elementary, middle, or high school, registered apprenticeship programs, and student loans are subject to state income tax and an additional 2.5% California tax. You should talk to a qualified advisor about how tax provisions affect your circumstances.

When you pull money out of the 529 to pay for student loans the money will be:

• subject to state income tax
• an additional 2.5% California tax

So even if you transfer the money to a 529 plan for you, at least part of the money will be subject to taxes when used to pay off a student loan.

My experience with 529 plans is that every withdraw is part contribution and part earnings.