Leftover 529 Money Can Pay Down a Grandchild’s Student Loans, Up to a Lifetime Limit
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Money left in a 529 college savings plan after graduation can go toward a beneficiary’s student loans, and if you saved in a 529 plan for a grandchild, that leftover balance can go toward student loans. You can use 529 money to pay student loans tax-free, up to a lifetime limit of $10,000 per person.
Student Loan Relief Sitting in Your 529
Federal law counts student loan payments as a qualified higher education expense, which is the tax term for costs a 529 can cover without anyone paying tax on the growth. It covers both principal (the amount borrowed) and interest. Each person’s cap is $10,000 over their lifetime. Each of the beneficiary’s siblings also gets a separate limit of the same size, and one account can pay down loans for several grandkids.
Where the Rule Lives in the Tax Code
To learn more about this rule, see 26 U.S.C. § 529(c)(9). The rule covers amounts paid “as principal or interest on any qualified education loan” of the beneficiary or the beneficiary’s sibling. Subparagraph (B) sets the lifetime ceiling. Subparagraph (C) says money spent on a sibling’s loans counts only against that sibling’s own limit. IRS Publication 970 for tax year 2025 says the same thing and defines a sibling as a brother, sister, stepbrother, or stepsister.
Which Grandkids Can Use It
The loans have to belong to the account’s beneficiary (the person the account was opened for) or to that person’s brother, sister, stepbrother, or stepsister. They must also be qualified education loans. The 529 rule borrows that definition from the student loan interest section of the tax code, section 221(d). Loans in a parent’s name aren’t covered by the rule because the borrower must be the beneficiary or a sibling. A cousin’s loans don’t count under the sibling rule either.
How to Pay Off a Grandchild’s Loans
- Check who the beneficiary is. If the grandchild with the loans isn’t named, you can switch the account to them. A change to another family member isn’t treated as a distribution, so it doesn’t trigger tax.
- Get a current loan statement that shows the balance and the borrower’s name.
- Ask your plan for a withdrawal to repay the loan, and keep a record of exactly where the money went.
- Keep a running total per person. The $10,000 limit shrinks with every dollar used in earlier years.
- Tell the borrower which payments came from the 529 so they can report them correctly at tax time.
More Ways to Spend What’s Left
Loans are just one option. You can pass the account to another family member who’s still headed to school. Graduate school costs count as higher education too. Fees, books, supplies, and equipment for an apprenticeship program registered with the Secretary of Labor also qualify.
You can also move money into a Roth IRA for the beneficiary. The account has to have been open for 15 years. Money added in the past 5 years, along with its earnings, can’t be moved. The money has to go directly from the plan to the Roth IRA.
Each year’s rollover is capped at that year’s Roth IRA contribution limit, minus anything else the beneficiary put into IRAs, while the lifetime total is $35,000. Our earlier 529 coverage explains how these accounts affect financial aid.
Traps That Can Cost Your Family Money
Interest paid with tax-free 529 money can’t also be claimed for the student loan interest deduction. The student loan interest deduction is reduced by the tax-free earnings portion of the 529 distribution used to pay interest, not necessarily the full withdrawal. The IRS says you can’t deduct as student loan interest any amount that came from tax-free 529 earnings.
States can set their own rules. Some don’t treat loan repayment as a qualified expense on the state return. In those states, the withdrawal could mean state income tax, or giving back a state deduction you took when you put the money in.
Spending on something that doesn’t qualify costs more. The earnings portion counts as taxable income, and on top of that comes an additional 10% tax on the taxable amount, which applies to 529 withdrawals. That extra 10% is waived if the beneficiary dies or becomes disabled. It’s also waived when the beneficiary gets a scholarship. The waiver is limited to the scholarship amount or the cost of attendance at a U.S. military academy, under 26 U.S.C. § 530(d)(4)(B). Regular income tax on the earnings still applies in those cases.
Ask This Before You Withdraw a Dollar
The federal rule is settled. Your state’s rule determines whether this move is completely tax-free. Call your plan or your state tax agency. Before you request the withdrawal, ask one question: does my state treat student loan repayment as a qualified expense?
Contact [email protected] for any questions or corrections.
David Beren has been a Flywheel Publishing contributor since 2022. Writing for 24/7 Wall St. since 2023, David loves to write about topics of all shapes and sizes. As a technology expert, David focuses heavily on consumer electronics brands, automobiles, and general technology. He has previously written for LifeWire, formerly About.com. As a part-time freelance writer, David’s “day job” has been working on and leading social media for multiple Fortune 100 brands. David loves the flexibility of this field and its ability to reach customers exactly where they like to spend their time. Additionally, David previously published his own blog, TmoNews.com, which reached 3 million readers in its first year. In addition to freelance and social media work, David loves to spend time with his family and children and relive the glory days of video game consoles by playing any retro game console he can get his hands on.
