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COLLEGE SAVINGS 101

Five things to know about 529s and financial aid
http://www.savingforcollege.com/articles/five-things-to-know-about-529s-and-financial-aid

Updated: 2016-02-11

by Joseph Hurley

Many people are concerned with the effects that the funds in a 529 college savings plan will have on a student's financial aid eligibility. To help clear up any confusion, here are a few things to remember about how 529 plans are treated under the federal aid formula.

1. The 529 account you established for your child may impact need-based financial aid.

As the custodial parent of a dependent student, your non-retirement investment assets are assessed at a maximum 5.64% rate in determining your child's Expected Family Contribution (EFC). Any 529 accounts under your ownership are counted as parent assets for this purpose.

For example, let's assume you have 529 accounts worth $10,000 on the day you file the FAFSA federal aid application. You must report the $10,000 along with your other countable assets, which will likely increase the EFC by $564. Higher EFC means less financial need.

Calculate your child's EFC here.

The 5.64% rate is significantly lower than the rate (20%) at which the student's own investment assets, including UGMA or UTMA accounts, are assessed. The parent's asset assessment rate could be even lower, depending on your income. For any family with federal adjusted gross income below $50,000, and which is otherwise eligible to file Form 1040A or 1040EZ, assets are not counted at all.

Your income is another factor in determining EFC. The income reported on this year's tax return must be included on next year's financial aid application. Tax-free distributions from a 529 plan are excluded from this "base-year" income. This exclusion provides 529 plans with an advantage over mutual funds and other taxable investment accounts that must be tapped for college.

2. The rules have changed for 529 accounts owned by your student.

If your child is owner of his or her 529 account, or if the account was set up as a "custodial" 529 using UGMA or UTMA funds, the account is subject to a special rule as of 2009. Rather than being reportable as a student asset, and assessed at 20% (before 2006) or at 0% (special treatment 2006-2008), the account must be reported as a parent asset even when the parent is not the owner. This keeps the assessment at the low 5.64% rate, enhancing your child's eligibility for aid.

3. The 529 accounts you own for the student's younger sibling can reduce eligibility.

It doesn't matter who the 529 beneficiary is: if you are the account owner and required to report parent assets, then the 529 account has to be included on the FAFSA. You can sometimes avoid a problem by converting your existing accounts for younger siblings to "custodial" 529 accounts. Like all custodial accounts, this will lock in the named beneficiary (i.e. you cannot change beneficiaries later on) and you must turn over direct control of the account to your child at age 18 or 21, depending on your state's UGMA and UTMA laws. Be careful, not all 529 plans will permit such a conversion.

Compare the benefits of 529 plans versus UGMA/UTMA accounts here.

4. Grandparent 529s can be good or not-so-good.

The FAFSA does not ask for the assets of grandparents or other relatives, even when those assets are earmarked for college. However, support provided to the student by someone other than a parent must be included with the student's base-year income* (see the discussion above). This includes distributions to the student taken from a grandparent-owned 529 plan. There are several strategies that can employed to minimize the negative impact of this, including waiting until the student's final year of college to withdraw grandparent-owned 529 funds.

*Beginning with the 2017-18 school year, financial aid eligibility will be based on income from two years prior to when they enroll in college.

Learn more about grandparent-owned 529 plans here.

5. School-based aid does not have to follow the federal formula.

Colleges can establish their own formulas in distributing their own scholarship and grant funds. While many follow the federal formula when making awards based on financial need, some do not. Colleges may specifically inquire about 529 accounts set up for the student and make adjustments to your child's award. Again, it's best to contact the school beforehand and ask how 529 plans are handled under its institutional aid formula.

See this year's top-performing 529 plans.

Many people are concerned with the effects that the funds in a 529 college savings plan will have on a student's financial aid eligibility. To help clear up any confusion, here are a few things to remember about how 529 plans are treated under the federal aid formula.

1. The 529 account you established for your child may impact need-based financial aid.

As the custodial parent of a dependent student, your non-retirement investment assets are assessed at a maximum 5.64% rate in determining your child's Expected Family Contribution (EFC). Any 529 accounts under your ownership are counted as parent assets for this purpose.

For example, let's assume you have 529 accounts worth $10,000 on the day you file the FAFSA federal aid application. You must report the $10,000 along with your other countable assets, which will likely increase the EFC by $564. Higher EFC means less financial need.

Calculate your child's EFC here.

The 5.64% rate is significantly lower than the rate (20%) at which the student's own investment assets, including UGMA or UTMA accounts, are assessed. The parent's asset assessment rate could be even lower, depending on your income. For any family with federal adjusted gross income below $50,000, and which is otherwise eligible to file Form 1040A or 1040EZ, assets are not counted at all.

Your income is another factor in determining EFC. The income reported on this year's tax return must be included on next year's financial aid application. Tax-free distributions from a 529 plan are excluded from this "base-year" income. This exclusion provides 529 plans with an advantage over mutual funds and other taxable investment accounts that must be tapped for college.

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