529 Plans Receive Favorable Treatment on the FAFSA

Kathryn FlynnBy Kathryn Flynn | 

A family’s income and assets are considered when determining a student’s financial aid eligibility. In some cases, a college fund can hurt a student’s eligibility for need-based financial aid. But, that doesn’t mean families should avoid saving for college.

The actual impact on financial aid eligibility depends on the type of account used to save for college, and who owns the account. 529 plan accounts owned by a parent or dependent student generally have a more favorable impact on financial aid eligibility than other types of investment accounts.

Ways to save for college

According to Sallie Mae’s 2018 How America Saves for College report, 22% of families use a general savings account to save for college. Saving in a general savings account is better than not saving for college at all, but there are other options that yield higher returns.

Some of the most common investment accounts used to save for college include:

These accounts all offer tax advantages that can help a family grow their college savings, but they have different effects on a student’s financial aid eligibility.

How income and assets affect financial aid eligibility

A student’s Expected Family Contribution (EFC) determines how much financial aid they are eligible to receive. The EFC is a measure of the family’s financial strength. The EFC is the amount a student is expected to be able to pay for college out of pocket based on their family’s financial circumstances.

The EFC is based on information provided on the student’s Free Application for Federal Student Aid (FAFSA). The EFC calculation considers the student’s income and assets and parent income and assets.

A student’s income and assets have a greater impact on financial aid than a parent’s income and assets:

  • 20% of the value of student assets are considered available funds to pay for college
  • 50% of a student’s income (after certain allowances) is considered available funds to pay for college
  • A maximum of 5.64% of a parent’s assets are considered available funds to pay for college
  • A maximum of 47% of parent income is considered available funds to pay for college

The asset protection allowance

For dependent students, a portion of their parents’ assets are sheltered by the asset protection allowance on the FAFSA. The amount of the asset protection allowance is set each year by the U.S. Department of Education and is based on the number of parents in the household and the age of the oldest parent.

However, parents should not rely on the asset protection allowance to shelter college savings. For a 48-year-old parent, the asset protection allowance has dropped from $52,000 in 2009-2010 to $6,000 in 2020-21.

All parent assets are disregarded on the FAFSA if the parents’ income is less than $50,000 and other criteria that satisfy the Simplified Needs Test.

Any remaining reportable parent assets after applying the asset protection allowance and the Simplified Needs Test are assessed at a maximum rate of 5.64%.

Financial aid impact of college savings accounts

529 plans offer the most favorable impact on financial aid. For example, consider a student with $10,000 saved for college. The student’s college savings would have the following impact on financial aid, depending on the type of account:

  • $10,000 saved in a 529 plan owned by a dependent student or the student’s parent reduces financial aid eligibility by up to $564
  • $10,000 saved in a Coverdell ESA reduces financial aid eligibility by up to $564
  • $10,000 saved in a student’s custodial bank or brokerage account reduces financial aid eligibility by $2,000
  • A $10,000 distribution from a grandparent-owned 529 plan may reduce financial aid eligibility by up to $5,000
  • A $10,000 distribution from a Roth IRA may reduce financial aid eligibility by up to $5,000

A Coverdell ESA has the same financial aid impact as a 529 plan, but there are other limitations that make a Coverdell ESA a less effective way to save for college. For example, only parents who meet certain income requirements may contribute to a Coverdell ESA and annual contributions are limited to $2,000 per beneficiary. 529 plans have no income limits and no contribution limits.

Financial aid impact of college savings

Type of Account

Funds held in the account

Qualified Distributions

529 Plan – Owned by Parent or Dependent Student

Reported as a parent asset, with up to 5.64% of value counted in EFC

Excluded from federal income tax and not reported on FAFSA

529 plan – Owned by a Grandparent or Other Third Party

Not reported as an asset on the FAFSA

Counted as untaxed student income, with up to 50% of distribution counted in EFC

Coverdell ESA

Reported as a parent asset, with up to 5.64% of value counted in EFC

Excluded from federal income tax and not reported on FAFSA

Roth IRA

Not reported as an asset on the FAFSA

Counted as taxable or untaxed income on the FAFSA, up to 50% of distribution counted in EFC

Custodial Account

Reported as a student asset, with 20% of value counted in EFC

N/A