529 plans and the FAFSA

http://www.savingforcollege.com/articles/529-plans-and-the-fafsa-709

It’s that time of year again. Current and prospective college students are working diligently with their families to ensure they receive as much financial aid as possible for the upcoming school year. Let’s face it; there aren’t too many families that can grab a quick $18,000 out of their wallet to pay for a year of school. Yes, you read that correctly – according to the College Board’s 2014 Trends in College Pricing report, the average costs of tuition, fees and room and board for the 2014-2015 school year at a public school was $18,943. If you’re going to a private university that number jumps to $42,419. These days if you want to get to college without going into debt, it’s going to take some work.

Fortunately, many families have been lucky enough to discover 529 college savings plans. With a 529 plan, any earnings on your investment grow tax-free and you’ll also avoid paying income tax on withdrawals if the money is spent toward post-secondary education. Some states also offer tax deductions or credits for residents who invest in their home states plan. Yet even those who have been saving are finding it difficult to come up with enough and will be hoping to supplement with federal financial aid this year.

The first step in applying for aid is to fill out the Free Application for Federal Student Aid (FAFSA). The FAFSA is a form used by the U.S. Department of Education to determine your eligibility for federal aid. Income, assets and other information from a family’s federal tax return are analyzed to calculate your Expected Family Contribution (EFC). The EFC represents how much a household is able to contribute to paying for college, so a higher EFC means less financial aid.

A 529 is generally your best bet

You may have heard that savings in a 529 account will increase your EFC and reduce your eligibility. While this is true, the effect 529 assets have on your financial aid eligibility is significantly less than the effect of other savings vehicles. Funds in a 529 account are considered parental assets, whether the account owner is the parent or the student. A parent’s non-retirement investment assets are assessed at a maximum rate of 5.64% when determining the EFC. Savings in UGMA/UTMA accounts, however, are considered a student’s assets and are assessed at 20%. That means if you have a 529 plan worth $100,000 on the day you file the FAFSA, your EFC will likely increase by $5640. But, if you instead chose to save with an UGMA/UTMA account, your EFC would have increased by $20,000, meaning much less financial aid for you.

Watch out for grandparent-owned 529s

Last year, 72 percent of grandparents surveyed by Fidelity felt it was important to help fund their grandchildren’s education. While we encourage grandparents to join in on the advantages of 529 plans, there are a couple things to keep in mind. If a grandparent takes a 529 distribution to pay for college expenses, the amount will be counted as student income on the following year’s FAFSA. When calculating your EFC, student income is assessed at a whopping 50%! To lessen the blow, grandparents can contribute to an account that is owned by the student or parent, or they can wait to make withdrawals until the student’s sophomore year of college, since the FAFSA requires students to report prior-prior year income.