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Opening Up the 529 Mailbag

We answer 529-related questions about college loans, study-abroad programs, and what happens to the money if you declare bankruptcy.

Adam Zoll, 09/24/2013

We've recently been getting lots of interesting reader questions related to 529-college-savings plans. So let's dive right in.

Question: Can I pay off my college loans with leftover 529 funds?

Answer: With so many recent (and not-so-recent) college grads grappling with college debt, it's no wonder this question comes up. But the fact is that 529 funds cannot be used to pay off college loans. 

The Internal Revenue Service requires that 529 assets be used only for qualified expenses, which include tuition, fees, books, supplies, room and board (if the student is carrying at least half of a full course load as defined by the school), and services required for enrollment by special-needs students. Even if you took out loans to pay for these things, the IRS also requires that 529 funds be withdrawn the same year the expenses were incurred. Withdrawals for unqualified expenses mean paying taxes on earnings plus a 10% penalty, so if you think you may need to take out loans at some point you're best off trying to use up 529 funds first. That way, you avoid paying taxes and the penalty, and also avoid having to take out a bigger loan.

If you do end up with unused 529 assets, one thing you can do to avoid paying taxes and a penalty is to roll them into a family member's 529 account. (You can read more about which family members are eligible here.) You might even see if there's a way for that family member to pay you back, which would provide you with cash to pay off your loan.

Question: What happens if I save money in a 529 and then my child attends college abroad? Do I forfeit the money?

Answer: Not necessarily. Assets in 529 plans may be used to pay for qualified expenses at more than 400 colleges outside the United States that have federal school codes. To see whether a specific school meets eligibility requirements, go to the U.S. Department of Education's Federal Student Aid website, select "Foreign Country" in the State drop-down menu, and type in the name of the school. Or to see a list of eligible schools, leave the "School Name" field blank. Foreign colleges that have federal school codes not only are eligible for students to use 529 funds but also allow federal financial aid. For study-abroad programs, 529 eligibility depends on the eligibility of the school to which tuition is paid during the program.

Once you've identified a foreign school and found its federal school code, it's a good idea to contact the school directly to confirm that you may use 529 funds to cover eligible expenses. And remember that 529 funds generally don't cover transportation costs, meaning you may end up paying out-of-pocket for airfare to and from the school.

Adam Zoll is an assistant site editor with Morningstar.com


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