SECURE Act – a New Opportunity to Save Taxes While Repaying Your Student Loans
At the end of 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law. As the name implies, much of the legislation was related to changing rules around retirement accounts. However, there were also several non-retirement related changes that have created new financial planning opportunities. One of those planning opportunities is a potential tax benefit if you are paying back student loans. For all the physicians out there with big student loan burdens they are working to pay off, it was refreshing to hear some positive news on this front.
What Are the Changes?
The SECURE Act extends the definition of “qualified education expenses” to include “qualified education loan repayments” of up to $10,000 (lifetime amount, not annually) of student loan repayments (principal and/or interest). This means withdrawals for up to $10,000 of student loan repayments qualify for tax-free distributions from a 529 plan.
What Is a 529 Plan?
A 529 plan is a tax-advantaged account that, until recently, has been used to save for higher education costs (college and post-graduate programs). In Michigan, when you contribute to the state 529 plan you are eligible to receive a state income tax deduction of up to $5,000/year if filing taxes as single or up to $10,000/year if filing taxes married filing jointly. Money in the account can be invested, grow tax-deferred, and be withdrawn tax-free if used for “qualified education expenses.”
I Don’t Have a 529 Plan – How Does This Impact Me?
This might not seem significant since most younger physicians don’t have a 529 plan and are instead working on paying back their own loans. However, with the changes, it might make sense to set up a 529 plan for your own benefit (as opposed to just using a 529 plan to save for your children’s future college expenses).
You can contribute to a 529 plan for yourself and receive a tax deduction of up to $10,000 on your Michigan state taxes if married filing jointly. From there, you can reimburse yourself for up to $10,000 of principal/interest payments made toward your student loans. Essentially, you use a 529 plan as a conduit to receive a tax deduction for loan payments you are already required to make.
Understand the Rules
In Michigan, the state tax deduction for 529 plan contributions is calculated based on your contributions to Michigan’s 529 plan minus any withdrawals of “qualified education expenses.” For example, if you contribute $10,000 to Michigan’s 529 plan in 2020 and reimburse yourself $10,000 in 2020 for student loan payments (or any other “qualified education expenses”), you will have $0 eligible for the deduction. A better way to do this would be to contribute $10,000 at the end of 2020, then make your withdrawal for “qualified education expenses” in 2021.
Keep in mind that you can only reimburse yourself for expenses in the same year they are incurred. So, using the example above, you’ll want to confirm there would be $10,000 of principal/interest payments in 2021 to ensure your withdrawals all count as “qualified education expenses.”
You’ll also want to be aware that, in certain situations, you may be eligible to deduct student loan interest if your Modified Adjusted Gross Income (MAGI) falls below certain thresholds, and this deduction can be impacted by withdrawals you make from your 529 plan to pay back student loans.
Each state has different rules as it pertains to 529 plans, so you’ll want to make sure you understand your state’s specific rules and consult with a tax professional before utilizing any tax-related strategy.
Conclusion
When it comes to taxes and student loans, no one wants to pay more than is required. While using a 529 plan to repay student loans won’t change the amount you have to pay toward your loans, it can at least allow you to save a little more on taxes in the process. As with many aspects of financial planning, consistently taking advantage of small opportunities like this can really add up over time.
Disclaimer: We are not licensed tax professionals and the content of this post does not constitute the issuance of tax advice. Please consult with a licensed tax professional to understand what is best for your personal situation.
About MD Wealth Management: We are an Ann Arbor financial planner that specializes in providing financial planning for physicians and retirees. We are CERTIFIED FINANCIAL PLANNER™ professionals and fiduciary financial advisors who operate on a fee-only basis, which means we do not sell financial products or collect commissions. As an Ann Arbor financial advisor, we enjoy working with clients both locally and remotely.