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COLLEGE SAVINGS 101

529s and Financial Aid (Script)

11/19/2014

QUESTION:
Joe,

I’m a proponent of 529’s. How do you counter the argument that saving in a 529 will diminish your kid’s chances of receiving financial aid from the institution that he or she applies to? Some of my peers argue that the aid package a university normally offers might be completely offset by the amount you save in a 529.


Mary

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ANSWER:
Dear Mary,

We first have to distinguish federal and institutional financial aid. The federal need-based student aid programs rely on the FAFSA, a form that reports student and parent assets and income. That information is plugged into a formula that computes the student’s expected family contribution or EFC. The EFC is the amount the family is expected to pay towards college, with the idea being that any excess college costs can be financed through a combination of federal Pell Grants, Stafford or Perkins loans, parent loans through the PLUS loan program, and federal work-study.

The federal EFC formula is very kind to 529 plans. Distributions are not reported as student or parent income as long as they come out tax-free, because they do not get included on the Form 1040 and they do not have to be added back on the FAFSA. This is a huge advantage over any mutual funds that throw off dividends and capital gains which get reported on the 1040 and therefore count as income on the FAFSA, and over IRA distributions because they either get reported on the 1040 or they don’t but then have to be added back on the FAFSA. Income is assessed in the EFC formula at very high rates, as high as 50%.

The asset value of the 529 plan is assessed in the EFC formula, but at the low parent’s rate of 5.64%. It could be less than 5.64%, based on the parent’s income level, and it could even be zero if assets stay below the asset protection allowance or if the student is eligible to file the simplified FAFSA form.

Institutional financial aid refers to assistance that does not come from the government, but rather from the school’s own resources. Of course, schools can do whatever they want with their own money and they may develop their own policies with regard to the impact a 529 plan will have on any institutional aid eligibility. Some schools piggyback on the federal EFC, some rely on a different form called the CSS PROFILE, and some come up with their own formulas. State schools tend to rely on the federal EFC.

Anyone who decides to save for college with a 529 plan and then finds their child wants to attend a private college should ask the college about their policies surrounding 529 plans as part of the college selection process. This will be just another factor in choosing a school. If it turns out that your child will lose a substantial amount of institutional aid because of the 529 plan, you always have the option of simply taking all your money out of the 529 plan, although that can lead to taxable income and a potential 10% penalty on the earnings. You might also consider changing the beneficiary and targeting use of the 529 plan to a different family member.

In the end you should remember that saving for college means that you will not have to rely as much on a school’s financial aid package because you will have the resources to pay for the college that’s right for your child, not necessarily the college with the best financial aid package. That’s the whole reason for setting aside funds in the first place.


Financial aid treatment – the income factor

529 plans
• Qualified distributions are tax-free
• Distributions do NOT get added back on FAFSA

Mutual funds
• Interest, dividends, and capital gains are taxable
• All 1040 income is included on FAFSA

IRAs
• Distributions may or may not be tax-free
• Tax-free portion gets added back on FAFSA

Financial aid treatment – the asset factor

529 plans
• Maximum of 5.64% of value gets included in EFC
• No inclusion if assets below asset protection allowance
• No inclusion if eligible for Simplified FAFSA


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