Dear Dr. Don,
Can I use 529 plan funds to pay off a Parent PLUS loan, which was used for qualified education expenses in 2011, without any tax consequences? I want to use the 529 funds to pay back the loan in 2011.
-- Richard Repayment
Using 529 plan monies to pay off a student loan only works if the qualified expenses funded by the loan occur in the same year as the 529 plan withdrawal. It does sort of beg the question as to why you got the loan in the first place.
It's not when you took out the loan, but when the qualified expenses were incurred that makes the difference. That's the match. The qualified expenses have to match up with the 529 plan withdrawal in the same calendar year.
Loans are not a qualified education expense. Because they aren't, 529 plan nonqualified withdrawals taken to pay off a student loan in situations other than the one described above may incur a 10% penalty tax on the gains withdrawn plus any federal and state income taxes due on the investment gains.