NerdWallet: What if you saved enough for college? Should you now get student loans instead?

Undergraduate federal student loan interest rates could fall below 3% for the first time in more than 15 years this July, based on the most recent 10-year Treasury note auction.

At the same time, parents with 529 college savings plans may have seen their account balances tumble during the coronavirus pandemic.

Should those savers now consider taking out loans for college instead?

“If you can get a loan at 3%,” says Melissa Ellis, a certified financial planner and founder of Sapphire Wealth Planning in Overland Park, Kansas, “why wouldn’t you?”

While that low rate looks good, here’s how to tell if this strategy is actually right for you.

You’ve lost money

Like other investments, 529 savings plans fluctuate due to market swings. Most 529s try to lessen that impact by switching from aggressive investments to more conservative ones as you get closer to paying for college.

If you stayed aggressive, your account may be underwater right now. Avoid panicking.

“Don’t knee-jerk entirely out of the market and lock in permanent losses,” says Vivian Tsai, chair of the College Savings Foundation, a nonprofit in Washington, D.C.

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Instead, consider taking federal student loans so you can stay invested long enough for your 529 to recover. Ideally, you’ll earn enough to negate any interest accruing on the loans as well.

You’d qualify for interest-free loans

You’ll be in even better shape if you qualify for subsidized federal loans, which don’t charge interest while your child attends school at least half time.

Subsidized loans are available to students who demonstrate financial need. That may not be the case for those with a 529.

According to Sallie Mae’s 2019 “How America Pays for College” report, the majority of families who contribute to 529s have incomes of more than $100,000.

The financial-aid award letter from your child’s school will state if you qualify for subsidized loans. If you’re waiting on an award, estimate your eligibility with the Department of Education’s Fafsa4caster tool.

You’re OK with risk

If you don’t qualify for a subsidized loan — and your 529 account remains in good shape — you may feel confident your earnings will exceed a potential 3% interest rate.

“This is probably a really good time to be able to expect better returns,” Ellis says. “Because anytime you have a very sharp downturn, at some point it’s going to come back.”

If you borrow, pay off the loan’s interest before it capitalizes, or is added to your balance. Otherwise, the amount you repay will increase, cutting your potential profit.

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Ian Aguilar, a CFP at Mellen Money Management in Ponte Vedra, Florida, agrees that “if you’re playing the pure mathematical game, you’re probably going to make out better with the markets.”

But he adds that the relatively short repayment term and small size of student loans limit the upside of this strategy.

“It’s not something I think you want to play with,” Aguilar says.

You have a non-parent 529

Regardless of your 529’s recent performance, you may want to wait to withdraw money if a grandparent or noncustodial parent owns the account.

When calculating federal financial aid, withdrawals from such accounts count toward the student’s income, which has “the harshest assessment rate,” says Shannon Vasconcelos, a college finance consultant at Bright Horizons College Coach, an educational adviser in Watertown, Massachusetts.

Students in this situation may want to opt for loans for their first year and a half in school.

“Once we hit that magic Jan. 1 of sophomore year,” Vasconcelos says, “the noncustodial parent can then pay off the student loans with the 529.”

That transaction would not affect future aid eligibility, she says.

Your state won’t tax you

529 savings plans are investment accounts in which earnings can grow and be used tax-free, provided the funds go toward eligible education expenses.

The 2019 Setting Every Community Up for Retirement Enhancement Act, or SECURE Act, made repaying up to $10,000 in student loans an eligible expense.

But not all states have aligned with this federal guidance, Vasconcelos says.

If yours doesn’t, you could be charged state taxes on withdrawals, and states might look to recapture your previous deductions for 529 contributions.

Reviewing your state’s history with past federal 529 changes can help you make an educated guess about potential penalties. For example, California and New York did not align with the 2018 change allowing 529 funds to be used for K-12 education expenses.

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