Tax-Free Tips and Overtime: What the Big Beautiful Tax Bill Means for Workers

By Michael Ruger, CFP®
Partner and Chief Investment Officer at Greenbush Financial Group

The Big Beautiful Tax Bill introduced two worker-friendly provisions aimed at boosting take-home pay: tax-free tips and tax-free overtime pay.

Starting in 2025, many employees in service-based and hourly industries will see a new opportunity to earn more without increasing their federal tax bill. But before you get too excited, there are income phaseouts that limit the benefit for higher earners, and both provisions are temporary—ending in 2028.

Let’s break down how each works, who qualifies, and how you might use this limited-time tax relief to your advantage.

Tax-Free Tips (2025–2028)

Under the new law, cash and electronic tips earned by employees will be excluded from federal income tax starting in 2025. This means waitstaff, bartenders, valets, and other tipped workers can keep more of their tips without paying federal income tax on that income.

Key Details:

• Up to $25,000 of qualified tip income is deductible

• Applies to all reported tips, including cash, credit card, and digital payment platforms (like Venmo or Square).

• Employers are still required to track and report tip income, but it won’t count toward federal taxable wages.

• FICA (Social Security and Medicare taxes) still apply to tips unless further guidance says otherwise.

Income Phaseouts for Tax-Free Tips

The benefit is phased out for higher earners. Once your income reaches a certain threshold, the tax-free status begins to shrink—and disappears entirely once fully phased out.  The $25,000 deduction amount is reduced by $100 for each $1,000 of modified AGI over $150,000 for single filers and $300,000 for joint filers.

If you’re within the phaseout range, the portion of your tips that are tax-free decreases gradually until it reaches zero.

Tax-Free Overtime Pay (2025–2028)

In a rare move to incentivize additional work hours, the bill also makes overtime pay exempt from federal income tax from 2025 through 2028. This applies to time-and-a-half wages earned beyond 40 hours per week.

Key Details:

• Up to $12,500 ($25,000 joint) of qualified overtime compensation is deductible

• Applies to hourly workers eligible for overtime under the Fair Labor Standards Act.

• Only the premium portion of overtime (typically the 1.5x wage rate) is tax-free. The base rate is still taxable.

• Overtime must be properly documented on pay stubs or employer payroll systems.

Income Phaseouts for Tax-Free Overtime

As with tax-free tips, this benefit is designed to help middle-income earners and begins to phase out at higher income levels. The phaseout calculation is the same as the tips deduction, the $12,500 deduction is reduced by $100 for each $1,000 of modified AGI over $150,000 (single) and $300,000 (joint). 

If your income falls within the range, only a portion of your overtime premium pay will be excluded from taxes. Above the threshold, none of the overtime qualifies for the exemption.

Could Employers Shift Salaried Workers to Hourly?

One of the more interesting (and perhaps unintended) consequences of the tax-free tips and overtime provisions is that it may incentivize employers to reclassify certain employees from salaried to hourly.

Here’s why:

• Only hourly workers are eligible for tax-free overtime under the new law.

• Salaried employees—particularly those exempt from overtime rules—don’t benefit at all from this provision.

• Employers looking to attract and retain workers in a competitive labor market may consider restructuring compensation models to help employees take advantage of the new tax savings.

For example, a business might:

• Reclassify a lower-level manager from salary to hourly, allowing them to earn overtime that’s now tax-free.

• Shift part of a base salary into a tip-eligible role (such as hybrid front-of-house service positions) to access the tax-free tip benefit.

Of course, this type of reclassification must be done carefully to remain compliant with wage and hour laws, and may not be appropriate in every industry. But in sectors like hospitality, healthcare, retail, and logistics, this kind of shift could become more common—particularly as employees become more aware of the tax advantages.

Planning Considerations

These two provisions present real planning opportunities for wage earners, especially those working in hospitality, retail, healthcare, and skilled trades.

1. Stack Your Hours Smartly

For hourly workers who are near the phaseout thresholds, it may make sense to shift hours into lower-income years to maximize the benefit.

2. Watch for Unintended Phaseout Triggers

Bonuses, side gigs, or spousal income could push you into the phaseout range and reduce or eliminate your tax-free eligibility. Tax planning with a professional can help you anticipate this.

3. Use the Extra Take-Home Pay Wisely

Since these benefits are temporary (expiring at the end of 2028), consider putting the extra income to work:

• Pay down high-interest debt

• Build your emergency fund

• Contribute more to retirement or a Roth IRA

• Save for large purchases without relying on credit

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions (FAQs):

What are the new tax-free tip and overtime provisions under the Big Beautiful Tax Bill?
Starting in 2025 and lasting through 2028, workers can exclude certain tip income and overtime pay from federal income tax. Up to $25,000 in tips and up to $12,500 ($25,000 for joint filers) in overtime pay may qualify each year, subject to income limits.

Who qualifies for the tax-free tip provision?
Hourly and service-based workers who earn tips—such as restaurant servers, bartenders, or valets—can exclude up to $25,000 of reported tip income from federal income tax. The deduction phases out for single filers with income above $150,000 and joint filers above $300,000.

How does the tax-free overtime pay rule work?
Hourly employees eligible for overtime under the Fair Labor Standards Act can exclude the “premium” portion of overtime pay (the extra half-time pay above their base rate) from federal income tax. The same income phaseouts apply as for tips.

Do workers still pay Social Security and Medicare taxes on tax-free tips and overtime?
Yes. Even though the new law exempts certain tips and overtime from federal income tax, FICA taxes (Social Security and Medicare) still apply unless further IRS guidance states otherwise.

Will salaried employees benefit from the new provisions?
No. Only hourly workers qualify for the tax-free overtime benefit. Some employers may consider reclassifying certain employees as hourly to allow them to take advantage, but any reclassification must comply with labor laws.

How long do the tax-free tip and overtime benefits last?
Both provisions are temporary. They take effect in 2025 and are scheduled to expire at the end of 2028 unless Congress extends them.

What should workers do with the extra take-home pay?
Since the benefits are short-term, consider using the additional after-tax income to pay down high-interest debt, build savings, or contribute to retirement accounts. A financial professional can help you plan the most effective use of the extra cash flow.

Big Beautiful Tax Bill Overhauls Student Loan Repayment Options: End of the SAVE Program

By Michael Ruger, CFP®
Partner and Chief Investment Officer at Greenbush Financial Group

The Big Beautiful Tax Bill has made headlines for reshaping major areas of the tax code but buried within the legislation is a sweeping overhaul of the federal student loan system, which will have long-term implications for both current and future borrowers.

If you—or your children—have federal student loans or plan to take them out, here’s what you need to know about repayment plans, loan forgiveness, and graduate borrowing limits as we head toward a new era in federal student aid.

Starting in 2026: Only Two Main Repayment Options

One of the biggest shifts takes effect in July 2026, when the federal government will consolidate most repayment options into just two primary plans for new borrowers:

1. Standard Repayment Plan

• Fixed monthly payments over 10 years

• Similar to current standard plans

• Ideal for borrowers with stable income who want to eliminate debt quickly

2. Repayment Assistance Plan (RAP)

• Monthly payments based on income and family size

• Forgiveness available after 20–30 years, depending on the loan type

• Unpaid interest does not capitalize annually, but continues to accrue

While the RAP offers more flexibility, it comes with a longer repayment horizon. This model mirrors existing income-driven plans, but with stricter forgiveness timelines and reduced subsidies over time.

Existing Income-Driven Repayment Plans Will Be Phased Out

The bill also mandates the sunset of current income-driven repayment (IDR) plans such as IBR, PAYE, REPAYE, and even the more recently introduced SAVE plan (discussed later).

Borrowers currently enrolled in these programs will have a transition period until 2028 to switch into the new Repayment Assistance Plan (RAP). After that date:

• New enrollment in existing IDR plans will be closed

• Borrowers will need to opt into RAP or move into the standard plan

• Previously accrued progress toward forgiveness may carry over, depending on guidance from the Department of Education (still pending)

Borrowers currently on track for loan forgiveness in an existing plan should carefully review how the transition may affect their timelines.

Graduate Borrowers Face New Loan Caps

Graduate and professional students—who often rely on federal student loans to cover the full cost of attendance—are facing new borrowing limits:

New Federal Caps for Graduate Borrowers (Effective 2026):

• $100,000 lifetime maximum for most graduate and professional programs

• Applies across all federal programs, including Graduate PLUS

• Borrowers may need to seek private loans or employer aid to cover costs beyond the cap

This is a dramatic departure from current rules, which allow grad students to borrow up to the full cost of attendance—including tuition, housing, and living expenses. Under the new system, graduate students will be expected to budget more conservatively or explore alternative financing.

Changes to the SAVE Program

The Saving on a Valuable Education (SAVE) plan, introduced in 2023 as a more generous income-driven repayment option, is also on the chopping block.

According to the Trump administration, the SAVE plan will:

• As of August 1, 2025, interest will begin accruing again for SAVE plan borrowers, even though they may still be in forbearance

• The SAVE Program will be eliminated by June 30, 2028, and borrowers will be moved into a new income-driven repayment plan called RAP.

• Lose features such as interest subsidies and lowered income thresholds for $0 monthly payments

For many, this means monthly payments could increase significantly once the SAVE subsidies disappear. Borrowers may also need to recalculate their budgets as interest builds up again and full payments resume.

If you're enrolled in SAVE, expect updates from your servicer in late 2025 outlining your transition options.

Forgiveness Becomes Taxable Again After 2025

One of the more overlooked but financially critical changes in the bill relates to taxation of forgiven student loan balances.

Currently, through the end of 2025, student loan forgiveness—whether through IDR, PSLF, or closed school discharge—is not considered taxable income at the federal level. That exclusion is set to expire.

Starting January 1, 2026, any federal student loan balance that is forgiven will be treated as taxable income by the IRS. This change has major implications for borrowers expecting loan forgiveness in the next 5–10 years.

Example: If $100,000 in student loans is forgiven in 2026, the borrower may owe federal taxes on that full amount—potentially triggering a $20,000+ tax bill depending on their bracket.

Borrowers approaching forgiveness in IDR plans may want to accelerate their timelines, if possible, or start preparing for a potential future tax liability.

Final Thoughts

The student loan system has been gradually shifting over the last few years, but the Big Beautiful Tax Bill accelerates those changes in a way that will permanently reshape how future generations borrow and repay federal loans.

Whether you're a current borrower navigating the SAVE sunset, a parent helping a graduate student manage new loan caps, or someone on track for forgiveness after 2025, proactive planning will be essential. Understanding the timing, tax implications, and repayment structures will help you avoid financial surprises in the years ahead.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions (FAQs)

What major changes does the Big Beautiful Tax Bill make to federal student loans?
Beginning in 2026, the law consolidates most federal student loan repayment options into two main plans—the Standard Repayment Plan and a new Repayment Assistance Plan (RAP). It also caps graduate borrowing at $100,000 and makes forgiven loan balances taxable again starting in 2026.

What are the two new repayment options starting in 2026?
Borrowers can choose between a 10-year Standard Repayment Plan with fixed payments or the new Repayment Assistance Plan (RAP), which bases payments on income and family size. The RAP offers forgiveness after 20–30 years, depending on loan type, but limits interest subsidies compared to current programs.

What happens to existing income-driven repayment (IDR) plans like SAVE, PAYE, or REPAYE?
These programs will be phased out by 2028. Borrowers currently enrolled in them can stay until the transition period ends but will eventually need to move into the new RAP or Standard Plan. Progress toward forgiveness may carry over, though official guidance is still pending.

How does the new law affect graduate and professional borrowers?
Starting in 2026, graduate students will face a $100,000 lifetime borrowing cap across all federal loan programs, including Graduate PLUS. Those who need additional funds may have to rely on private loans, scholarships, or employer tuition assistance.

What happens to the SAVE repayment plan under the new law?
The SAVE plan will begin phasing out in 2025 and be fully eliminated by June 30, 2028. Borrowers will lose features such as interest subsidies and lower payment thresholds. They will be moved automatically into the new RAP once SAVE ends.

Will student loan forgiveness be taxable again?
Yes. Starting January 1, 2026, any federal student loan balance that is forgiven—through income-driven repayment, PSLF, or other discharge programs—will once again be treated as taxable income by the IRS. Borrowers expecting forgiveness soon should prepare for potential tax liability.

How should borrowers prepare for these changes?
Review your repayment plan, understand your eligibility under the new RAP, and talk to a financial or tax advisor about potential tax implications. If you’re approaching forgiveness before 2026, accelerating repayment or adjusting your timeline may reduce future tax exposure.

IRS Gifting Rules: Tuition vs. Student Loan Payments

As the cost of college and private school continues to rise, it's increasingly common for extended family members—not just parents—to want to assist with the cost of tuition or student loan payments after graduation. However, many of those family members are surprised to learn that there are different gift tax and tax reporting rules that are dependent upon whether a direct tuition payment is made versus just helping with student loan payments post-graduation.

Tuition Payment Gift Exclusion

Because there are different gift tax rules that apply when making a tuition payment on behalf of someone else versus making a student loan payment for someone else, we will start with the tuition payment scenario first. Oddly enough in the eyes of the IRS, when someone makes a tuition payment for another person, the IRS does not view it as a “gift”. However, if that same person instead decides to help a family member pay off their student loans, the IRS views that action as a “gift”.  So, when we have grandparents who want to help their grandchildren pay for college, we often advise them to provide their support as tuition payments directly to the college as opposed to allowing their grandchild to take the student loans and then assisting them in repaying the student loans after they have graduated. 

As long as the tuition payment is made directly to the college from the family member, it does not constitute a gift, and gifting limits do not apply. However, if the money is not remitted directly to the college, then the gifting rules do apply.  Sometimes, family members make the mistake of giving money directly to the student or the parents of the student to make the tuition payments; if that happens, they have now made a gift and must follow the gift tax and reporting rules.

What about tuition for a K-12 private school?  The tuition gift exclusion also applies to tuition payments for preschool and K-12 private schools. 

Another important note, the gift exception only applies to tuition. It is not extended to room and board. If a non-parent pays for the room and board on behalf of a student, it is considered a gift.

Student Loan Payment Gift Tax Rules           

When someone makes a loan payment on behalf of someone else, the IRS considers that a gift.  This is true whether the money is given to the individual and then they make the loan payment, or if payments are made directly to the loan servicer on behalf of the college student / graduate. As mentioned earlier, there are gift reporting rules and potential gift tax implications that the individual making the gift or loan payment needs to be aware of.

Annual Gift Exclusion

For 2025, the annual gift exclusion amount is $19,000, which, for purposes of this article, means any one person can make a student loan payment for someone else up to $19,000 per year without having to worry about filing a gift tax return or paying gift tax. The number of people to whom the annual gift exclusion amount is applied is infinite, meaning if a grandparent has 3 grandchildren, and they all have student loans, a single grandparent could make student loan payments up to $19,000 for EACH grandchild, and they are completely covered by the annual gift exclusion.  No action needed.

If there are two grandparents, you can double the exclusion per grandchild to $38,000, since they each have a $19,000 annual gift exclusion. 

For example, Jen graduated from college with $35,000 of student loan debt; her 2 grandparents would like to pay off the $35,000 on her behalf by sending a check directly to the servicer of the student loan.  Since the amount is under the $38,000 joint filer gift exclusion amount, a gift tax return does not need to be filed, and no gift taxes are due. 

If instead Jen had $50,000 in student loan debt, we might advise her grandparents to remit the max gift amount this year ($38,000) and then as soon as we flip into January of the next tax year, they can remit the remaining amount ($12,000) which is also under the annual exclusion limit since it resets each year.

Gifting Over the Annual Exclusion Amount

If a student loan payment is made on behalf of a family member that exceeds the annual gift exclusion amount, a gift tax return would need to be filed in the tax year the student loan payment was made.  This, however, does not mean that gift tax is due.

The IRS provides a “lifetime gift tax exclusion” amount of $13.9 million per tax filer, meaning each person would have to gift over $13.9 million during their lifetime before any gift tax is due.  For a married couple, double that to $27.8 million.   Thus, only the ultra-wealthy typically have to worry about paying gift tax.   

Be aware that state gifting limits can vary from the federal limits, so depending on what state you live in, you may or may not owe gift tax at the state level.

While gift tax may not be due on the student loan payment that is made, just remember that if the student loan payment exceeds the annual gift exclusion amount, a gift tax return still needs to be filed.

No Tax Impact For The Person Receiving The Gift

When a cash gift is made or a student loan payment is made on behalf of someone else, the person with the student loans in their name or the recipient of the gift does not incur a tax event.  It’s a tax-free event for the recipient.  If gift tax is triggered, it is paid by the person making the gift, not the person who benefited from the gift.

Estate Planning Strategy

There are a number of estate planning strategies that can be implemented, acknowledging these gift tax rules.

1. For individuals looking to shrink the size of their estate – either to avoid estate taxes or just to begin gifting to family members - tuition payments offer a unique advantage. Since direct tuition payments do not count as gifts, this opens up the ability to make tuition payments directly to a pre-school, K-12 private school, or college that are in excess of the $19,000 annual gift exclusion amount in an effort to shrink the size of the estate or avoid the headache of the gift tax filing process.

2. If you want to make a gift to your child, grandchild, or other family member, but you do not want to give them the cash directly, making a payment directly to the student loan service provider can ensure that the gift is used towards the outstanding student loan balance, but it is still subject to the gift tax and reporting requirements.

3. What if you have some family members who have student loans, but others do not, and you want to gift equally?  Option 1: Give each family member a check for the annual gift exclusion amount and tell them they can do whatever they want with the cash, apply it toward a student loan, fund a Roth IRA, down payment on a house, etc.  Option 2: You can send payments directly to the loan service provider for the family members who have student loans and make direct gifts to the family members without loans.  All personal preference.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions (FAQs):

Are tuition payments considered gifts for tax purposes?
No. When tuition payments are made directly to an educational institution on behalf of a student, the IRS does not consider them gifts. This means they are not subject to annual gift limits or gift tax reporting, as long as the payment is sent directly to the school and not to the student or their parents.

Does the tuition payment gift exclusion apply to private school?
Yes. The exclusion applies to qualified tuition payments made directly to preschools, K–12 private schools, and colleges. However, it only covers tuition — payments for room, board, books, or other expenses are considered gifts and subject to normal gift tax rules.

What are the gift tax rules for helping pay off student loans?
Payments made toward someone else’s student loans are considered gifts by the IRS, even if paid directly to the loan servicer. The 2025 annual gift exclusion allows up to $19,000 per person, per recipient ($38,000 for a married couple) to be gifted without filing a gift tax return.

What happens if my gift or loan payment exceeds the annual exclusion amount?
If your total gifts to one person exceed $19,000 in 2025, you must file a gift tax return. However, most people will not owe gift tax because the lifetime gift and estate tax exemption is $13.9 million per person ($27.8 million per couple). Filing is required, but tax is rarely due.

Do recipients pay taxes on gifts or student loan payments made for them?
No. The person receiving the gift or having their loan paid on their behalf does not owe taxes. If a taxable gift is made, any gift tax owed is the responsibility of the giver, not the recipient.

Can tuition payments or gifts help with estate planning?
Yes. Direct tuition payments are an effective way to reduce the size of an estate without affecting your annual or lifetime gift exclusions. For families seeking to lower estate tax exposure, paying tuition directly for children or grandchildren can be a powerful estate planning tool.

Can I combine tuition payments and student loan gifts for one person?
Yes, but only the direct tuition payment is excluded from gift limits. Any additional help—such as paying student loans or covering living expenses—counts toward the annual $19,000 gift exclusion per recipient.

Rules for Using A 529 Account To Repay Student Loans

When the Secure Act passed in 2019, a new option opened up for excess balances left over in 529 accounts called a “Qualified Loan Repayment” option.  This new 529 distribution option allows the owner of a 529 to distribute money from a 529 account to repay student loans for the beneficiary of the 529 account AND the beneficiary’s siblings.  However, this distribution option is not available to everyone, and there are rules and limits associated with these new types of distributions.

State Level Restrictions

While the Secure Act made this option available at the Federal level, it’s important to understand that college 529 programs are sponsored at the state level, and the state’s allowable distribution options can deviate from what’s allowed at the Federal Level.  For example, specific to this Qualified Loan Repayment option, the Secure Act began allowing these at the Federal Level in 2019, but New York did not recognize these as “qualified distributions” from a 529 account until just recently, in September of 2024. 

So, if an owner of a NYS 529 account processed a distribution from the account and applied that amount toward a student loan taken by the beneficiary of the account, it often triggered negative tax events such as having to pay state income tax and a 10% penalty on the earnings portion of the distribution, as well as a recapture of the state tax deduction that was given from the contributions to the 529 account.  Fortunately, some states like New York are beginning to change their 529 programs to more closely match the options available at the Federal level, but you still have to check the distribution rules in the state that the account owner lives in before processing distributions from a 529 to repay student loans for the account beneficiary and/or their siblings.

$10,000 Lifetime Limit 

There are limits to how much you can withdraw from a 529 account to apply toward a student loan balance.  Each BORROWER has a $10,000 lifetime limit for qualified student loan repayment distributions. It’s an aggregate limit per child.  So, if the child has multiple 529 accounts that they are the beneficiary of, it’s an aggregate limit of $10,000 between all of their 529 accounts. This is true even if the 529 accounts have different owners. For example, if the parents have a 529 account for their child with a $30,000 balance and the grandparents have a 529 account for the same child with a $10,000 balance, there’s an aggregate limit of $10,000 between both 529 accounts, meaning parents cannot take a $10,000 distribution and apply it toward the child’s student loan balance, and then the grandparents distribute an additional $10,000 to apply to that same child’s outstanding student loan balance.

Sibling Student Loan Payments

In addition to being able to distribute $10,000 from the 529 and apply it towards the account beneficiary's outstanding student loans, the account owner can also distribute up to $10,000 for each sibling of the 529 account beneficiary and apply that toward their outstanding student loan balance.  The definition of siblings includes sisters, brothers, stepbrothers, and stepsisters.

Parent Plus Loans

If the parents took out Parent Plus Loans to help pay for their child’s college, after distributing $10,000 to repay student loans in their child’s name, they could then change the beneficiary on the 529 to themselves and distribute $10,000 to repay any outstanding Parent Plus loans taken in the parent’s name since the parent is considered a different “borrower”. 

Most but Not All Student Loans Qualify

Most Federal and private student loans qualify for repayment under this special 529 distribution option. However, there is additional criteria to make sure a private student loan qualifies for repayment.  The list is too long to include in this article, but just know if you plan to take a distribution from a 529 account to repay a private student loan, additional research is required.

Forfeiting Student Loan Interest Tax Deduction

If a distribution is made from a 529 account and applied toward a student loan, it may limit the taxpayer’s ability to deduct the student loan interest when they file their taxes. The student loan interest deduction is currently $2,500 per year.   Whether or not the distribution from the 529 will limit or eliminate the $2,500 tax deduction will depend on how much of the 529 distribution was made to repay the student loans cost basis versus earnings. 

Example: If a parent distributes $10,000 from their child’s 529 account and applies it toward their outstanding student loan balance, and $6,000 of the $10,000 was cost basis (what the parent originally contributed to the 529) and $4,000 was earnings, the earnings portion of the distribution is applied against the $2,500 student loan tax deduction amount. So, any distributions made from a 529 to repay a student loan with earnings equal to or greater than $2,500 would completely eliminate the student loan tax deduction for that year.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions (FAQs):

What is the 529 Qualified Loan Repayment option?
The Qualified Loan Repayment option allows 529 plan owners to use funds from a 529 account to repay student loans for the account’s beneficiary and the beneficiary’s siblings. This provision was introduced under the Secure Act in 2019.

Are all states required to allow 529 loan repayment distributions?
No. While the Secure Act allows these distributions at the federal level, each state determines whether they qualify as tax-free distributions under its own rules. For example, New York did not recognize these as qualified distributions until September 2024. Before that, loan repayments from a 529 could trigger state income tax, penalties, and loss of prior deductions.

What is the lifetime limit for 529 loan repayment distributions?
Each borrower has a $10,000 lifetime limit for student loan repayments made using 529 funds. This is an aggregate limit per borrower across all 529 accounts, even if the accounts are owned by different people.

Can 529 funds be used to pay a sibling’s student loans?
Yes. Up to $10,000 can be distributed for each sibling of the 529 account beneficiary to repay their student loans. Siblings include brothers, sisters, stepbrothers, and stepsisters.

Can 529 funds be used to repay Parent PLUS loans?
Yes. After using $10,000 for the child’s student loan, the 529 owner can change the beneficiary to themselves and take another $10,000 distribution to repay Parent PLUS loans in their own name.

Do all student loans qualify for repayment with 529 funds?
Most federal and private student loans qualify. However, private loans must meet specific IRS criteria to be eligible. Account owners should verify loan eligibility before making a 529 distribution for private student loans.

How does using a 529 to pay loans affect the student loan interest deduction?
Using 529 funds to repay student loans may reduce or eliminate eligibility for the $2,500 annual student loan interest deduction. The portion of a 529 distribution that represents earnings (not contributions) is counted against this deduction. For example, if $4,000 of a $10,000 529 distribution represents earnings, the full $2,500 deduction could be lost for that tax year.

Biden's New SAVE Plan: Lower Student Loan Payments with Forgiveness

With student loan payments set to restart in October 2023, the Biden Administration recently announced a new student loan income-based repayment plan called the SAVE Plan.  Not only is the SAVE plan going to significantly lower the required monthly payment for both undergraduate and graduate student loans for many borrowers, but there is also a 10-year to 25-year forgiveness period built into the new program.  While the new SAVE program is superior in many ways to the current student loan repayment options, it will not be the right fit for everyone. In this article, we will cover:

• How does the new SAVE Plan work?

• How does the SAVE program compare to other student loan repayment options?

• How are the monthly payments calculated under the SAVE program?

• What type of loans qualify for the SAVE plan?

• How do you apply for the new SAVE plan?

• How does loan forgiveness work under the SAVE plan?

• Who should avoid enrolling in the SAVE plan?

• The new Fresh Start Plan to wipe away defaults and delinquent payments in the past

The SAVE Student Loan Repayment Plan

The SAVE plan is a new Income-Driven Repayment Plan (IDR) for student loans that also contains a loan forgiveness feature.   The monthly payments under this program are based on a borrower’s annual income and household size.  Once a borrower is enrolled in the SAVE program, any balance remaining on the loan is forgiven after a specified number of years.

Replacing The REPAYE Plan

The SAVE Plan will be replacing the current REPAYE plan, but the terms associated with the SAVE plan are enhanced.  Any borrowers previously enrolled in the REPAYE plan will automatically be transitioned to the SAVE plan.   

What Types of Loans Are Eligible?

Only federal student loans are eligible for the SAVE plan.  Private student loans and Parent PLUS loans are not eligible for this repayment option.  Both federal undergraduate and graduate student loans are eligible for the SAVE plan, but the monthly payment calculation and forgiveness terms differ depending on whether the borrower has undergraduate loans, graduate loans, or both.  

SAVE Plan Monthly Payment Calculation

There are several income-driven repayment plans currently available to borrowers, but those plans typically require the borrower to commit 10% to 20% of their discretionary income toward their student loan payments each year.  The new SAVE plan will only require individuals with undergraduate loans to commit 5% of their discretionary income toward their student loan payments each year.  As mentioned above, individuals currently enrolled in the REPAYE plan, which requires a 10% of income payment, will automatically be transitioned to the SAVE plan, which could lower their monthly payment amount.   

Definition of Income

The SAVE program limits the borrower to only having to pay 5% of their household discretionary income toward their undergraduate loan balance each year.  While that seems pretty straightforward, there are a few terms that we need to define here.  First, it’s 5% of household income, meaning if you are married and file a joint tax return, you must use your combined income when applying for the SAVE plan.  If there are two incomes, that could naturally raise the amount you pay each month toward your student loans.

However, if a borrower is married but chooses to file their tax return, married filing separately instead of married filing jointly, then only the spouse applying for the SAVE plan has to report their income.  While at first this might seem like a no-brainer, I would urge extreme caution before electing to file your tax return married filing separately.  While this tactic could lower the required monthly payments for your student loan and potentially increase the forgiveness amount at the end, electing to file as married filing separately could dramatically increase your overall tax liability depending on the income level between the two spouses. It creates a situation where you could win on the student loan side but lose on the tax side.  For this reason, I strongly encourage married couples to consult with their tax advisor before completing the SAVE plan application.  

If you are a single filer, there is nothing to worry about; it’s just your income.

We also have to define the term discretionary income.   Discretionary income usually means your total income minus all your living expenses like rent, groceries, utilities, etc.  But that is not how it’s defined for purposes of the SAVE plan, which makes sense because everyone has different living expenses.  For purposes of the 5% SAVE plan calculation, your discretionary income is the difference between your adjusted gross income (AGI) and 225% of the U.S. Department of Health and Human Services Poverty Guideline based on your family size.

For 2023, here are the Federal Poverty Levels based on family size:

• Individuals:         $14,580

• Family of 2:         $19,720

• Family of 3:         $24,860

• Family of 4:         $30,000

The list continues as the size of the family increases, and these amounts change each year.  Let’s look at an easy example:

• Sarah is a single tax filer

• She has $80,000 in undergraduate federal student loans

• Her adjusted gross income (AGI) is $40,000

Here is how her student loan payment would be calculated under the SAVE Plan. 

1. Adjusted Gross Income: $40,000

2. Minus 225% of Individual Household Poverty Rate:  $32,805 ($14,580 x 225%)

3. Equals:  $7,195

4. Multiply by 5%:  $359.75

So Sarah would only have to pay $359.75 for the YEAR (about $30 per month) toward her student loan under the new SAVE plan. 

Some Borrowers Will Pay $0

No payments will be required under the SAVE plan for borrowers with an adjusted gross income below 225% of the Federal Poverty Level.  In the example above, if Sarah’s AGI was only $30,000, since her $30,000 in income is below 225% of the Federal Poverty threshold of $32,805, she would not be required to make any monthly student loan payment under the SAVE plan until her income rises above the 225% threshold.

Size of the Household

As you can see above, it’s not just the annual income amount that determines how much a borrower will pay under the SAVE plan but also how many individuals there are within that person's household.  More specifically, they ask for individuals who qualify as your “dependents.”  If Sarah is a single filer with 2 roommates, she cannot claim those roommates as household members for the SAVE repayment plan.   The SAVE application specifically asks for the following:

• How many children, including unborn children, are in your family and receive more than half of their support from you?

• How many other people, excluding your spouse and children, live with you and receive more than half of their support for you?

Studentaid.gov has the following illustration posted on their website to give borrowers a rough estimate of what the monthly payment student loan payment will be based on varying levels of income and family size:

The 5% Payment Will Take Effect July 2024

You will notice something odd in the illustration above.  When I presented the example with Sarah, her AGI was $40,000 for a household of 1, which resulted in an estimated monthly payment of $30 but the chart above says $60 per month. Why?  Under the current REPAYE plan which the SAVE plan is replacing, the payment amount is 10% of discretionary income.  The lower 5% of discretionary income amount associated with the new SAVE plan is not expected to be phased in until July 2024.  This means that borrowers who enroll in the SAVE plan now, while their payment may still be lower than that standard 10-year repayment plan, they will have to pay 10% of their discretionary income toward their student loans until they reach July 2024 when the new 5% rule becomes effective.

Going Into Effect in 2023

There are three components of the SAVE Plan that are going into effect in 2023, some of which we have yet to address in this article.

1. The larger income shield.  Most of the current income-based student loan repayment plans only shield the borrower’s AGI up to 100% to 150% of the Federal Poverty Level compared to the new SAVE plan’s 225%.  Under the SAVE plan, the 225% shield is in effect for 2023 reducing the amount of the borrower’s AGI subject to the current 10% repayment allowance.  Also, more borrowers will be completely relieved of making payments when they restart in October because the income protection threshold is higher under the SAVE Plan.

2. The treatment of unpaid interest:  We have not covered this yet but we will later on, the treatment of unpaid interest and the compounding of the interest for loans covered by the SAVE plan will be much more favorable for borrowers. This feature goes into effect in 2023.

3. Married Filing Separately:  Married couples who choose to file their tax return married filing separately will no longer be required to include their spouse’s income in their monthly payment calculation under the SAVE plan. 

Graduate Loans

The more favorable 5% income repayment amount that takes effect in July 2024 is only available for undergraduate loans under the SAVE plan.  Individuals with graduate loans are eligible to enroll in the SAVE program but the minimum payment amount is based on 10% of discretionary income instead of 5%. 

For borrowers that have both undergraduate and graduate student loans, they will take a weighted average between their undergraduate loans at 5% and graduate loans at 10% to reach the percent of discretionary income that will be required under the SAVE payment plan.  Example: If you have $20,000 in undergraduate loans and $60,000 in graduate loans, you have $80,000 in student loans in total: 25% are undergraduate and 75% are graduate.

• 5% x 25% =          1.25%

• 10% x 75% =       7.50%

• Average Weighted:  8.75%

This borrower would have to commit 8.75% of their discretionary income toward their SAVE student loan repayment plan.

SAVE Plan Loan Forgiveness

There is also a loan forgiveness component associated with the new SAVE Plan.  Once you have made payments on your student loan for a specified number of years, any remaining balance is forgiven.  The timeline to forgiveness under the SAVE plan can range from 10 years to 25 years. The original principal balance of your student loan or loans is what determines your forgiveness timeline.   

Beginning in July 2024, borrowers who had original student loan balances of $12,000 or less, may be required to make monthly payments in accordance with the income-based payment plan, but after 10 years, any remaining loan balance is completely forgiven.

For each $1,000 in original student loan debt over the $12,000 threshold, they add one year to the borrower's forgiveness timeline up to the maximum of 20 years for undergraduate debt and 25 years for graduate debt.   For example, Sue has a student loan with a current balance of $ 8,000 but the original principal balance of the loan was $14,000. Since Sue is $2,000 over the $12,000 threshold, her forgiveness timeline will be 12 years. If Sue continues to make income-based payments under the SAVE plan, any remaining balance after year 12 is completely forgiven. 

Payments Made In The Past Count Toward Forgiveness

A big question for borrowers, for years that you had already made student loan payments, do those years count toward your SAVE plan forgiveness timeline?  Good news, the answer is “Yes” and it gets better. You also receive credit for the specific periods of deferment and forbearance which will count toward the forgiveness timeline.

For example, Jeff graduated from college in 2017, he has an original loan balance of $20,000 and made payments on his student loans in 2017, 2018, 2019, and then did not make any student loan payments 2020 – 2023 due to the COVID relief.  Jeff enrolls in the SAVE repayment plan.  Since his original loan balance was $8,000 over the $12,000 10-year threshold, his timeline to forgiveness is 18 years. However, because Jeff started making student loan payments in 2017 and he also receives credit for the years of deferred payments under the COVID relief, he is credited with 7 years toward his 18-year forgiveness timeline.  After Jeff has made another 11 years' worth of income-based student loan payments under the SAVE program, any remaining loan balance will be forgiven.

Forgiveness May Trigger A Taxable Event

If you are forgiven all or a portion of your student loan balance, you may have to pay taxes on the amount of the loan forgiveness. It states right on the SAVE plan application that “forgiveness may be taxable”.   As of 2023, forgiven loan balances are a tax-free event but that rule sunsets in 2025.  With the SAVE plans having a 10-year to 25-year forgiveness period, who knows what the tax rules will be when those remaining loan balances become eligible for forgiveness. 

Borrowers Who Consolidate Multiple Loans

It’s not uncommon for college graduates to have 3 or more federal student loans outstanding at the same time because they will typically take multiple student loans over their college tenure and then at some point consolidate all of their loans together.  When borrowers consolidate all of their loans into one under the SAVE plan, they receive a credit for a weighted average of payments that count toward forgiveness based upon the principal balance of loans being consolidated.  

That’s the technical way of saying if you consolidate two of your student loans into one and the first loan that you consolidated began repayment 9 years ago and had a $1,000 original balance but then you consolidated it with a second loan with an original balance of $8,000 that you just started making payments on last year, if you qualify for 10-year forgiveness under the SAVE plan, the full loan balance will not be forgiven next year which would be the 10th year since you started making payments on the $1,000 loan.  They are going to weigh the balance of each loan and how long you have been making payments on each loan to determine how much credit you receive toward your forgiveness timeline once enrolled in the SAVE plan.

Does Interest Accumulate In The SAVE Plan?

A concern will often arise with these income-based repayment plans that if your income is low enough and it does not require you to make a payment or if the payment is very small, does the interest on the student loan continue to accumulate which in turn continues to increase the amount that you own on your student loan?

Under the new SAVE plan, the answer is “No”.  The SAVE plan cancels unpaid interest.  For example, if under the SAVE plan your monthly payment is $150 but the monthly interest on your loan is $225, instead of the $75 being added to your loan balance, the $75 in unpaid interest is canceled by the Education Department.  This new feature associated with the SAVE plan will prevent outstanding loan balances from ballooning due to unpaid compounding interest.

Loan Defaults and Delinquent Borrowers (Fresh Start Program)

The Department of Education is giving all student loan borrowers a fresh start under what is specifically called the Fresh Start Program.  For all borrowers that either fell into default prior to the COVID payment pause or have delinquent student loan payments on their credit history, all student loan borrowers are allowed to enroll in the new Fresh Start program which brings everyone current regardless of what their student loan payment history was prior to the COVID payment pause.

But action needs to be taken prior to September 2024 to qualify for this Fresh Start. This does not happen automatically. I have been told that you will need to contact either the Education Department’s Default Resolution Group or your student loan service provider and ask to be enrolled in the Fresh Start Program.   Once in the Fresh Start Program, the loan default and/or late payments are also permanently removed from your credit report.

How Do You Enroll In The SAVE Plan?

To enroll in the SAVE plan, you can visit the StudentAid.gov website.   You will be able to apply for the SAVE program, get an estimate of what your monthly payment amount will be, and ask any questions that you have about the SAVE program.  You can also call 1-800-433-3243.   There is also a printable PDF of the SAVE application that you can download from the website.

SAVE is one of many “Income-Driven Repayment” (IDR) plans that are available to borrowers.  Fortunately, on the first page of the SAVE application, you can check a box that says, “I want the income-driven repayment plan with the lowest monthly payment.” For many borrowers, this will be the new SAVE plan, but if one of the other IDR programs like IBR, PAYE, or ICR offers a lower monthly payment, you will be enrolled in that Income-Driven Repayment Plan.

The SAVE Plan Is Not For Everyone

While there are no income limitations that restrict borrowers from enrolling in the SAVE Plan, this plan will not be the right fit for everyone. It will take careful consideration on the part of each borrower to determine if they should enroll in the SAVE plan, continue with the standard 10-year repayment plan, or select a different Income-Driven Repayment option.  Right on the SAVE application, it states that there is no cap on that amount of the monthly payment and “your payments may exceed what you would have paid under the 10-year standard repayment plan”. 

Everyone’s situation will be different depending on your annual income amount, the size of your outstanding loan balance, the type of loans that you have, the size of your household, tax filing status, how long you have already been paying on your loans, and what you can afford to pay each month toward your student loans.  

In general, for higher-income earners with small to medium-sized loan balances, the SAVE program may not make sense because the payments under the SAVE program are based solely on your income and household size rather than your loan balance.

The Monthly Payment Amounts Change Each Year

Since the SAVE Plan is an income-driven repayment plan, your required monthly payment amount can vary each year as your income level and household size change. If you were making $30,000 as a single filer in 2024, you might not be required to make any payments, but if you change jobs and begin earning $80,000 per year, your payments could increase dramatically under these Income-Driven Repayment plans. 

In the past, these income-driven repayment plans have been a headache to maintain because you had to go through the manual process of recertifying your income each year, but there is good news on this front.  The SAVE plan will give borrowers the option to give the Department of Education access to the IRS database to pull their income from their tax return automatically each year to avoid the manual process of recertifying their income each year. Section 5A of the SAVE application is titled “Authorization to Retrieve Federal Tax Information From the IRS”, so you can elect this when you enroll in the SAVE plan.

You Are Not Locked Into The SAVE Plan

Once you are enrolled in the SAVE plan, you are not locked into it.  At any time, you may change to any other student loan repayment plan for which you are eligible, so if your circumstances change in the future, you could enroll in a different repayment option that better meets your financial situation.

Student Loan Repayment Strategy

As borrowers, it's very tempting to quickly select the student loan repayment program that offers the lowest monthly payment amount, but that may not be the best long-term financial solution.  As I mentioned before, the standard repayment schedule for student loans is fixed payments over 10 years.  With the SAFE plan potentially lowering the monthly payment amounts and stretching the loan out over a longer duration, borrowers could end up paying more over the life of that loan. In addition, for borrowers aiming for forgiveness, it isn’t easy to know what your income may be 5+ years from now.  

While interest does not compound in the SAVE program, if your payments are only being applied toward the interest portion of your loans, the principal amount of the loan is not decreasing, which could cause you to pay more over that 20 to 25-year period than you would have just keeping the standard payment schedule a paying off your loan in 10 years.  While forgiveness may be waiting for you after 20 years, it could trigger a taxable event, making the forgiveness target even less attractive.

The SAVE program is positive because it may give some borrowers much-needed relief as student loan payments restart and for borrowers just graduating from college.  However, for borrowers who enroll in the SAVE program, it may make financial sense to ignore the forgiveness aspect of the program and pay more than just the minimum monthly payment to pay off the loans faster.  Debt-free living is a wonderful thing.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions (FAQs):

What is the SAVE student loan repayment plan?
The SAVE Plan is a new income-driven repayment (IDR) option that replaces the former REPAYE plan. It bases monthly payments on a borrower’s income and family size, and forgives any remaining balance after 10 to 25 years of qualifying payments.

How are SAVE Plan payments calculated?
Monthly payments are generally set at 5% of a borrower’s discretionary income for undergraduate loans and 10% for graduate loans. Discretionary income is the difference between a borrower’s adjusted gross income (AGI) and 225% of the federal poverty guideline for their household size.

When does the 5% payment rate under the SAVE Plan take effect?
While borrowers can enroll now, the 5% discretionary income payment rate for undergraduate loans becomes effective in July 2024. Until then, borrowers will pay 10% of their discretionary income, similar to the previous REPAYE plan.

Which student loans qualify for the SAVE Plan?
Only federal student loans are eligible for the SAVE Plan. Private student loans and Parent PLUS loans do not qualify. Borrowers with both undergraduate and graduate federal loans will have a weighted average payment rate based on the loan types.

How does loan forgiveness work under the SAVE Plan?
Forgiveness occurs after 10 to 25 years of payments, depending on the original loan balance and loan type. For example, borrowers with $12,000 or less in original federal loans may receive forgiveness after 10 years, with one additional year added for each $1,000 above that amount.

Does unpaid interest continue to grow under the SAVE Plan?
No. Under the SAVE Plan, any unpaid interest is canceled rather than added to the loan balance. This prevents balances from growing due to compounding interest when monthly payments are low or temporarily paused.

What is the Fresh Start program for student loans?
The Fresh Start program allows borrowers with defaulted or delinquent federal loans to restore their accounts to good standing. It removes previous defaults from credit reports, but borrowers must contact the Education Department or their loan servicer before September 2024 to enroll.

Is the SAVE Plan the best option for every borrower?
Not necessarily. While the SAVE Plan can significantly lower monthly payments, higher-income borrowers or those with smaller loan balances may pay more over time compared to the standard 10-year plan. Borrowers should compare repayment options and consider long-term costs before enrolling.

Big FAFSA Calculation & Application Changes Starting in 2023

Parents that are used to completing the FAFSA application for their children are in for a big surprise for FAFSA Application years 2023+.  Not only is the FAFSA application being completely revamped but the FAFSA calculation itself is being changed which could result in substantially lower financial aid awards for many college-bound students.

A Simplified FAFSA Application

Completing the FAFSA application can be a very frustrating process; tons of questions, unclear wording as to what information FAFSA is actually asking parents to report, and you have to spend a lot of time collecting all of your personal financial documents that are needed to enter the information on the FAFSA application.

Fortunately, in 2020, Congress passed the FAFSA Simplification Act which greatly simplified the FAFSA application in 2023 and years going forward.  The old FAFSA application contained 108 questions, the new FAFSA application is only expected to contain 36 questions.  In addition to cutting the questions in half, the wording of many of the questions were amended to make it easier to understand how to report your financial assets. Two very welcome changes to the application.

EFC (Expected Family Contribution) Calculation Removed

In the past, completing the FAFSA application has resulted in an Expected Family Contribution (EFC) amount which is meant to provide a ballpark amount that a family may have to pay out of pocket before need-based financial aid is awarded to a student.  The term EFC can be misleading because it’s not necessarily the hard dollar amount that parents will be required to pay out of pocket but rather it’s the family’s financial need relative to other applicants.

To remove this confusion, EFC is now be replaced by SAI (Student Aid Index), so now after parents complete the FAFSA application, it will result in an SAI amount.

Financial Aid Awards Reduced For Multiple Children

Parents that have multiple children in college at the same time may be in for an unfortunate surprise when they see the results of the new SAI calculation.  In the past, if a parent completed the FAFSA application and it resulted in an EFC of $30,000, but they had two children in college at the same time, FAFSA would split the $30,000 between the two children, $15,000 each, which would potentially make each student eligible for a higher financial aid award.

Starting the 2024 – 2025 school year, FAFSA no longer provides this EFC (SAI) split for multiple children in college.  If the FAFSA calculation results in a $30,000 SAI, that $30,000 will now apply to EACH student, instead of being split equally between each child, which could result in lower need-based financial aid awards going forward.

Divorced Parents FAFSA Calculation Change

When parents are divorced, and they have a child attending college, the custodial parent is the parent that submits the FAFSA application based on their income and assets.  Historically, the FAFSA definition of the “custodial parent” was the parent that the child lived with for the majority of the 12-month period ending on the day the FAFSA application is filed.   This often times created a very favorable financial aid award if the child was living for a majority of the year with the parent that had lower income and assets.

This will change for years 2023 and going forward. The new FAFSA rules require the parent who provided the most financial support in the “prior-prior” tax year to complete the FAFSA application instead of the custodial parent.   Prior-prior refers to the tax year 2 years ago from the beginning of the college semester.  For the 2025 – 2026 award year, FAFSA will look at the 2023 tax year for this determination.

For example, Joe and Sue got divorced 5 years ago, and their daughter Mary is currently a sophomore in college. Sue is a homemaker,  Mary lives with her mother for the majority of the year, Joe makes $300,000 per year, and pays Sue $25,000 per year in child support and $40,000 per year in alimony.   For the 2023 – 2024, under the old FAFSA calculation, Sue was considered the custodial parent, and completed the FAFSA form using her annual income and assets.  Since Joe is not the custodial parent, Joe’s income and assets are ignored for purposes of FAFSA. 

Starting in the 2024 – 2025 school year, under the new rules, that has now changed.  Since Joe is providing a majority of the financial support via child support and alimony payments, Joe would now be the parent required to submit the FAFSA application based on his income and assets.  Since Joe’s income is substantially higher than Sue’s, it could result in a much lower college financial aid award.

There has been some initial guidance, that if there is a “tie” as to which parent provided the majority of the financial support, the ties are broken based on whichever parent has the higher adjusted gross income.

Changes to Pell Grants

One of the largest sources of need-based financial aid from the federal government is awarded via Pell Grants. Starting in the 2024 – 2025 school year, the maximum Pell Grant amount was increased but they have changed how the Pell Grant is calculated.   The Pell Grant takes into account both the SAI result (new EFC) and the applicant’s adjusted gross income. Since the calculation of the SAI has changed, for reasons that we have already discussed, it could impact the amount of the Pell Grants awarded to students.

As a new benefit, parents will now be able to determine if their child will be eligible for a Pell Grant award based on income and family size before they even complete the FAFSA form.

Grandparent 529 Penalty Removed

A positive change that they made was eliminating the restriction associated with distributing money from a 529 account owned by a grandparent for the benefit of the grandchild.  Previously, if distributions were made from a grandparent owned 529 accounts, those distributions were considered “income of the student” in the FAFSA calculation, which could dramatically reduce the financial aid awards in future years. The new legislation removed this restriction and made grandparent owned 529 accounts even more valuable than they were prior to this change.

Income Protection Allowance Increased

The FAFSA calculation has income thresholds that exclude specific amounts of income of both the parents and the child in the calculation of the Student Aid Index.   Those income exclusion allowances were increased starting in 2024.    The income protection allowance for parents was increased by about 20%.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions (FAQs):

What is changing with the FAFSA application starting in 2023?
Beginning with the 2023–2024 academic year, the FAFSA is being redesigned under the FAFSA Simplification Act. The number of questions has been reduced from 108 to about 36, and the language has been simplified to make it easier for families to understand and complete the form.

What is the difference between EFC and SAI?
The Expected Family Contribution (EFC) has been replaced with the Student Aid Index (SAI). While both estimate a family’s financial ability to contribute toward college costs, the new SAI formula is designed to simplify the process and remove confusion surrounding the term “expected contribution.”

How will the new FAFSA rules affect families with multiple children in college?
Under the old FAFSA calculation, the EFC was divided among multiple students in college, potentially increasing need-based aid for each child. Starting with the 2024–2025 school year, that split no longer applies—each student will have the same SAI, which may reduce financial aid eligibility for families with multiple college students.

How are FAFSA rules changing for divorced or separated parents?
Previously, the “custodial parent”—the one the student lived with most—was responsible for filing FAFSA. Beginning in 2024–2025, the parent who provided the most financial support during the “prior-prior” tax year must complete the application. This change may increase the reported household income for some families, reducing aid eligibility.

What are the new rules for Pell Grants?
Starting in 2024–2025, Pell Grant eligibility will be determined based on the new SAI formula and household adjusted gross income. While the maximum Pell Grant amount is increasing, the new calculation could alter eligibility for some students. Families will also be able to check Pell Grant eligibility before completing the FAFSA form.

How do the new rules affect 529 plans owned by grandparents?
Distributions from grandparent-owned 529 plans will no longer be counted as student income in the FAFSA formula. This change removes a previous penalty that reduced financial aid eligibility, making grandparent-owned 529 plans more advantageous.

What is the Income Protection Allowance and how is it changing?
The Income Protection Allowance excludes a portion of a family’s income from the aid calculation to protect funds for basic living expenses. Starting in 2024, these thresholds are increasing by roughly 20%, allowing more income to be shielded from the FAFSA formula and potentially increasing aid eligibility.

Top 10: Little-Known Facts About 529 College Savings Accounts

While 529 college savings accounts seem relatively straightforward, there are a number of little-known facts about these accounts that can be used for advanced wealth planning, tax strategy, and avoiding common pitfalls when taking distributions from these accounts.

1:  Roth Transfers Will Be Allowed Starting in 2024

Starting in 2024, the IRS will allow direct transfers from 529 accounts to Roth IRAs.  This is a fantastic new benefit that opens up a whole new basket of multi-generation wealth accumulation strategies for families.   

2: Anyone Can Start A 529 Account For A Child

Do you have to be the parent of the child to open a 529 account?  No.  529 account can be opened by parents, grandparents, aunts, or friends.  Even if a parent has already established a 529 for their child there is no limit to the number of 529 accounts that can be opened for a single beneficiary.

3:  State Tax Deduction For Contributions

There are currently 38 states that offer either state tax deductions or tax credits for contributions to 529 accounts.  Here is the list.  There are no federal tax deductions for contributions to 529 accounts.   Also, you don’t have to be the parent of the child to receive the state tax benefits.

4:  A Tax Deduction For Kids Already In College

For parents that already have kids in college, if you have not already established a 529 account and you are issuing checks for college tuition, for states that offer tax deductions for contributions, you may be able to open a 529 account, contribute to the account up to the state tax deduction limit, and as soon as the check clears, request a distribution to pay the college expenses. This allows you to capture the state tax deduction for the contributions to the account in that tax year.

5:  Rollovers Count Toward State Tax Deduction

If you just moved to New York and have a 529 with another state, like Vermont, you are allowed to roll over the balance of the Vermont 529 account into a New York 529 account for the same beneficiary and those rollover amounts count toward the state tax deduction for that year.  We had a New York client that had a Vermont 529 for their daughter with a $30,000 balance, and we had them rollover $10,000 per year over a 3-year period to capture the maximum NYS 529 state tax deduction of $10,000 each year.

6:   Not All States Allow Distributions for K – 12 Tuition Expenses

In 2018, the federal government changes the tax laws allowing up to $10,000 to be distributed from a 529 account each year to pay for K – 12 tuition expenses.  However, if you live in a state that has state income taxes, states are not required to adopt changes that are made at the federal level. There are a number of states, including New York, that do not recognize K – 12 tuition expenses as qualified expenses so the earnings portion of those withdrawals would be subject to state income tax and recapture of the tax deductions that were awarded for those contributions.

7: Transfers Between Beneficiaries

529 rules can vary state by state but most 529 accounts allow account owners to transfer all or a portion of balances between 529 account with different beneficiaries. This is common for families that have multiple children and a 529 account for each child. If the oldest child does not use their full 529 balance, all or a portion of their 529 account can be transferred the 529 accounts of their younger siblings.

8:  Contributions Can Be Withdrawn Tax and Penalty Free

If you ever need to withdraw money from a 529 account that is not used for qualified college expenses, ONLY the earnings are subject to taxes and the 10% penalty.  The contributions that you made to the account can always be withdrawn tax and penalty-free.

9:  529 Accounts May Reduce College Financial Aid

The balance in a 529 account that is owned by the parent of the student counts against the FAFSA calculation.  Fortunately, assets of the parents only count 5.64% against the financial aid award, so if you have a $50,000 balance, it may only reduce the financial aid award by $2,820.  However, 529 accounts owned by a grandparent or another relative, are invisible to the FAFSA calculation.

10:  Maximum Balance Restrictions

529 plans do not have annual contribution limits but each state has “aggregate 529 plan limits”. These limits apply to the total 529 balances for any single 529 beneficiary in a particular state.  Once the combined 529 plan balances for that beneficiary reach a state’s aggregate limit, no additional contributions can be made to any 529 plan administered by that state.  Luckily, the limits for most states are very high.  For example, the New York limit is $520,000 per beneficiary.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions (FAQs):

Can 529 plan funds be rolled into a Roth IRA?
Yes. Starting in 2024, the IRS allows direct transfers from 529 plans to Roth IRAs under certain conditions. This rule lets unused education savings continue growing tax-free for retirement, offering families a powerful long-term wealth planning opportunity.

Who can open a 529 plan for a child?
Anyone—not just parents—can open a 529 plan for a child. Grandparents, relatives, and even family friends can establish and contribute to an account. Multiple 529 plans can exist for the same beneficiary, allowing flexible savings options across family members.

Do 529 plan contributions qualify for tax deductions?
There is no federal tax deduction for 529 plan contributions, but 38 states currently offer a state income tax deduction or credit. You don’t need to be the child’s parent to claim the state tax benefit if you are the account owner making the contribution.

Can parents claim a 529 deduction if their child is already in college?
Yes. In many states, parents can open and fund a 529 account, then immediately use the funds to pay qualified college expenses. This strategy captures a same-year state tax deduction while paying existing tuition bills.

Do 529 rollovers from another state qualify for tax deductions?
Often, yes. Some states, such as New York, allow rollovers from out-of-state 529 plans to count toward the annual state tax deduction limit, provided the funds remain for the same beneficiary.

Are K–12 tuition payments allowed from a 529 plan?
Federal law permits up to $10,000 per year in 529 withdrawals for K–12 tuition, but not all states recognize this as a qualified expense. In states that don’t, earnings may be subject to state income tax and potential deduction recapture.

Can 529 funds be transferred between children?
Yes. Most 529 plans allow tax-free transfers between siblings or other qualifying family members. This flexibility helps families reallocate unused education funds among multiple children.

What happens if 529 funds are used for non-education expenses?
Withdrawals of contributions are always tax- and penalty-free. However, earnings withdrawn for non-qualified expenses are subject to ordinary income tax and a 10% federal penalty.

Do 529 plans affect college financial aid eligibility?
Yes, but the impact is small. Parent-owned 529 assets count as parental resources on the FAFSA and reduce aid eligibility by only 5.64% of the account’s value. 529 plans owned by grandparents are not reported on FAFSA but may affect aid when distributions are made.

Is there a maximum amount you can save in a 529 plan?
While there’s no annual contribution limit, states impose aggregate balance limits per beneficiary, typically exceeding $400,000. For example, New York’s limit is $520,000 per student, after which no additional contributions can be made.

529 to Roth IRA Transfers: A New Backdoor Roth Contribution Strategy Is Born

With the passing of the Secure Act 2.0, starting in 2024, owners of 529 accounts will now have the ability to transfer up to $35,000 from their 529 college savings account directly to a Roth IRA for the beneficiary of the account.  While on the surface, this would just seem like a fantastic new option for parents that have money leftover in 529 accounts for their children, it is potentially much more than that.  In creating this new rule, the IRS may have inadvertently opened up a new way for high-income earners to move up to $35,000 into a Roth IRA, creating a new “backdoor Roth IRA contribution” strategy for high-income earners and their family members. 

Money Remaining In the 529 Account for Your Children

I will start by explaining this new 529 to Roth IRA transfer provision using the scenario that it was probably intended for; a parent that owns a 529 account for their children, the kids are done with college, and there is still a balance remaining in the 529 account.

The ability to shift money from a 529 account directly to a Roth IRA for your child is a fantastic new distribution option for balances that may be leftover in these accounts after your child or grandchild has completed college.   Prior to the passage of the Secure Act 2.0, there were only two options for balances remaining in 529 accounts:

1. Change the beneficiary on the account to someone else

2. Process a non-qualified distribution from the account

Both options created potential challenges for the owners of 529 accounts.  For the “change the beneficiary option”, what if you only have one child, or what if the remaining balance is in the youngest child’s account? There may not be anyone else to change the beneficiary to. 

The second option, processing a “non-qualified distribution” from the 529 account, if there were investment earnings in the account, those investment earnings are subject to taxes and a 10% penalty because they were not used to pay a qualified education expense.

The “Roth Transfer Option” not only gives account owners a third attractive option, but it’s so attractive that planners may begin advising clients to purposefully overfund these 529 accounts with the intention of processing these Roth transfers after the child has completed college.

Requirements for 529 to Roth IRA Transfers

Before I get into explaining the advanced tax and wealth accumulation strategies associated with this new 529 distribution option, like any new tax law, there is a list of rules that you have to follow to be eligible to process these 529 to Roth IRA transfers.

The 15 Year Rule

The first requirement is the 529 account must have been in existence for at least 15 years to be eligible to execute a Roth transfer from the account.  The clock starts when you deposit the first dollar into that 529 account.  The planning tip here is to fund the 529 as soon as you can after the child is born, if you do, the 529 account will be eligible for Roth IRA transfers by their 15th or 16th birthday.

There is an unanswered question surrounding rollovers between state plans and this 15-year rule.  Right now, you are allowed to rollover let’s say a Virginia 529 account into a New York 529 account.  The question becomes, since the New York 529 account is a new account, would that end up re-setting the 15-year inception clock?

Contributions Within The Last 5 Years Are Not Eligible

When you go to process a Roth transfer from a 529 account, contributions made to the 529 account within the previous 5 years are not eligible for Roth transfers. 

The Beneficiary of the 529 Account and the Owners of the Roth IRA Must Be The Same Person

A third requirement is the beneficiary listed on the 529 account and the owner of the Roth IRA account must be the same person.   If your daughter is the beneficiary of the 529 account, she would also need to be the owner of the Roth IRA that is receiving the transfer directly from the 529 account.  There is a big question surrounding this requirement that we still need clarification on from the IRS.  The question is this: Is the account owner allowed to change the beneficiary on the 529 account without having to re-satisfy a new 15-year account inception requirement? 

If they allow beneficiary changes without a new 15-year inception period, with 529 accounts, the account owner can change the beneficiary on these accounts to whomever they want……..including themselves.  This would allow a parent to change the beneficiary to themselves on the 529 account and then transfer the balance to their own Roth IRA, which may not be the intent of the new law. We will have to wait for guidance on this.

No Roth IRA Income Limitations

As many people are aware, if you make too much, you are not allowed to contribute to a Roth IRA.  For 2023, the ability to make Roth IRA contributions begins to phase out at the following income levels:

Single Filer:  $138,000

Married Filer: $218,000

These transfers directly from 529 accounts to the beneficiary’s Roth IRA do not carry the income limitation, so regardless of the income level of the 529 account owner or the beneficiary, there a no maximum income limit that would preclude these 529 to Roth IRA transfers from taking place.

The IRA Owner Must Have Earned Income

With exception of the Roth IRA income phaseout rules, the rest of the Roth RIA rules still apply when determining whether or not a 529 to Roth IRA transfer is allowed in a given tax year.  First, the beneficiary of the 529 (also the owner of the Roth IRA) needs to have earned income in the year that the transfer takes place to be eligible to process a transfer from the 529 to their Roth IRA.  

Annual 529 to Roth IRA Transfer Limits

The amount that can be transferred from the 529 to the Roth IRA is also limited each year by the regular Roth IRA annual contribution limits.  For 2023, an individual under the age of 50, is allowed to make a Roth IRA contribution of up to $6,500.   That is the most that can be moved from the 529 account to Roth IRA in a single tax year.  But in addition to this hard dollar limit, you have to also take into account any other Roth IRA contributions that were made to the IRA owner’s account and the IRA owners earned income for that tax year.

The annual contribution limit to a Roth IRA for 2023 is actually the LESSER of:

• $6,500; or

• 100% of the earned income of the account owner

Assuming the IRA contribution limits stay the same in 2024, if a child only has $3,000 in income, the maximum amount that could be transferred from the 529 to the Roth IRA in 2024 is $3,000.

If the child made a contribution of their own to the Roth IRA, that would also count against the amount that is available for the 529 to Roth IRA transfer.  For example, the child makes $10,000 in earned income, making them eligible for the full $6,500 Roth IRA contribution, but if the child contributes $2,000 to their Roth IRA throughout the year, the maximum 529 to Roth IRA transfer would be $4,500 ($6,500 - $2,000 = $4,500)

The IRA limits could be the same or potentially higher in 2024 when this 529 to Roth IRA transfer option goes into effect.

$35,000 Limiting Maximum Per Beneficiary

The maximum lifetime amount that can be transferred from a 529 to a Roth IRA is $35,000 for each beneficiary.  Given the annual contribution limits that we just covered, you would not be allowed to just transfer $35,000 from the 529 to the Roth IRA all in one shot.  The $35,000 lifetime limit would be reached after making multiple years of transfers from the 529 to the Roth IRA over a number of tax years.

Advanced 529 Planning Strategies Using Roth Transfers

Now I’m going to cover some of the advanced tax and wealth accumulation strategies that may be able to be executed under this 529 Roth Transfer provision.  Disclosure, writing this in February 2023, we are still waiting on guidance from the IRS on what they may or may not have intended with this new 529 to Roth transfer option that becomes available starting in 2024, so their guidance could either reinforce that these strategies can be used or limit the use of these advanced strategies. Time will tell.

Super Funding A Roth IRA For Your Child

While 529 accounts have traditionally been used to save exclusively for future college expenses for your children or grandchild, they just become much more than that.   Parents and grandparents can now fund these accounts when a child is young with the pure intention of NOT using the funds for college but rather creating a supercharged Roth IRA as soon as that child begins earning income in their teenage years and into their 20s. 

This is best illustrated in an example.  You have a granddaughter that is born in 2023, you open a 529 account for her and fund it with $15,000.  By the time your granddaughter has reached age 18, let’s assume through wise investment decisions, the account has tripled to $45,000.  Between ages 18 and 21, she works a summer job making $8,000 in earned income each year and then gets a job after graduating college making $80,000 per year.  Assuming she made no contributions to a Roth IRA over the years, you would be able to make transfers between her 529 account and her Roth IRA up to the annual contribution limit until the total transfers reached the $35,000 lifetime maximum. 

If that $35,000 lifetime maximum is reached when she turns age 24, assuming she also makes wise investment decisions and earns 8% per year on her Roth IRA until she reaches age 60, at age 60 she would have $620,000 in that Roth IRA account that could be withdrawal ALL TAX-FREE. 

Now multiply that $620,000 across EACH of your children or grandchildren, and it becomes a truly fantastic way to build tax-free wealth for the next generation.

529 Backdoor Roth Contribution Strategy

A fun fact, there are no age limits on either the owner or beneficiary of a 529 account.  At the age of 40, I could open a 529 account, be the owner and the beneficiary of the account, fund the account with $15,000, wait the 15 years, and then when I turn age 55, begin processing transfers directly from the 529 to my Roth IRA up to the maximum annual IRA limit each year until I reach my $35,000 lifetime limit. 

I really don’t care that the money has to sit in the 529 for 15 years because 529 accumulate tax deferred anyways, and by the time I hit age 59.5, making me eligible for tax-free withdrawal of the earnings, I will have already moved most of the balance over to my Roth IRA. Oh and remember, even if you make too much to contribute directly to a Roth IRA, the income limits do not apply to these 529 to Roth IRA direct transfers.

The IRS may have inadvertently created a new “Backdoor Roth IRA Contribution” strategy for high-income earners.  

Now there may be some limitations that can come into play with the age of the individual executing this strategy, it’s really less about their age, and more about whether or not they will have earned income 15 years from now when the 529 to Roth IRA transfer window opens.  If you are 65, fund a 529, and then at age 80 want to begin these 529 to Roth IRA transfers, if you have no earned income, you can process these 529 to Roth IRA transfers because you are limited by the regular IRA annual contribution limits that require you to have earned income to process the transfers.

Advantage Over Traditional Backdoor Roth Conversions

For individuals that have a solid understanding of how the traditional “Backdoor Roth IRA Contribution” strategy works, the new 529 to Roth IRA transfer strategy potentially contains additional advantages over and above the traditional backdoor Roth strategy. These movements from the 529 to Roth IRA are not considered “conversions”, they are considered direct transfers. Why is that important? Under the traditional Backdoor Roth Contribution strategy the taxpayer is making a non-deductible contribution to a traditional IRA and then processes a conversion to a Roth IRA. 

One of the IRS rules during this conversion process is the “aggregation rule”.  When a Roth conversion is processed, the taxpayer has to aggregate all of their pre-tax IRA balance together in determining how much of the conversion is taxable, so if the taxpayer has other pre-tax IRAs, it came sometimes derail the backdoor Roth contribution strategy.  If they instead use the 529 to Roth IRA direct transfer processes, since as of right now it is not technically a “conversion”, the aggregate rule is avoided.

The second big advantage is with the 529 to Roth IRA transfer strategy, the Roth IRA is potentially being funded with “untaxed earnings” as opposed to after-tax dollar. Again, in the traditional Backdoor Roth Strategy, the taxpayer is using after-tax money to make a nondeductible contribution to a Traditional IRA and then converting those dollars to a Roth IRA. If instead the taxpayer funds a 529 with $15,000 in after-tax dollars, but during the 15-year holding, The account grows the $35,000, they are then able to begin direct transfers from the 529 to the Roth IRA when $20,000 of that account balance represents earnings that were never taxed. Pretty cool!!

State Tax Deduction Clawbacks?

There are some states, like New York, that offer tax deductions for contributions to 529 accounts up to annual limits.  When the federal government changes the rules for 529 accounts, the states do not always follow suit.  For example, when the federal government changed the tax laws allowing account owners to distribute up to $10,000 per year for K – 12 qualified expenses from 529 accounts, some states, like New York, did not follow suit, and did not recognize the new “qualified expenses”.  Thus, if someone in New York distributed $10,000 from a 529 for K – 12 expenses, while they would not have to pay federal tax on the distribution, New York viewed it as a “non-qualified distribution”, not only making the earnings subject to state taxes but also requiring a clawback of any state tax deduction that was taken on the contribution amounts.   

The question becomes will the states recognize these 529 to Roth IRA transfers as “qualified distributions,” or will they be subject to taxes and deduction clawbacks at the state level? Time will tell.  

Waiting for Guidance From The IRS

This new 529 to Roth IRA transfer option that starts in 2024 has the potential to be a tremendous tax-free wealth accumulation strategy for not just children but for individuals of all ages. However, as I mentioned multiple times in the article, we have to wait for formal guidance from the IRS to determine which of these advanced wealth accumulation strategies will be allowed from tax years 2024 and beyond.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions (FAQs):

What is the new 529 to Roth IRA transfer rule under the Secure Act 2.0?
Starting in 2024, owners of 529 college savings accounts can transfer up to $35,000 over their lifetime from a 529 directly to a Roth IRA for the account’s beneficiary. This gives families a new tax-free way to repurpose unused education savings.

What are the main requirements for a 529 to Roth IRA transfer?
The 529 account must be at least 15 years old, and contributions made within the last 5 years cannot be transferred. The 529 beneficiary and the Roth IRA owner must be the same person, and the beneficiary must have earned income in the year of transfer.

How much can be transferred each year?
Transfers are subject to the annual Roth IRA contribution limit—currently $6,500 per year (or less if earned income is lower). It may take several years to reach the $35,000 lifetime transfer cap.

Do income limits apply to 529 to Roth IRA transfers?
No. These transfers are not subject to Roth IRA income phaseouts, meaning high-income earners can use this rule even if they’re normally ineligible to contribute directly to a Roth IRA.

Can parents use this rule as a backdoor Roth IRA strategy?
Potentially. If future IRS guidance allows changing a 529 beneficiary to oneself without restarting the 15-year clock, high-income earners could fund their own Roth IRAs using this method—creating a new type of “backdoor Roth” strategy.

Are there potential state tax implications?
Yes. Some states may not treat 529-to-Roth transfers as qualified distributions, which could trigger state taxes or clawbacks of prior state tax deductions.

When will the IRS provide more guidance on this rule?
The IRS is expected to issue clarifications before the rule takes effect in 2024. Guidance will determine whether advanced strategies—like beneficiary changes or state conformity—are allowed.