If you’re considering using a 529 plan to save for future college costs, you may be worried about hurting your child’s eligibility for federal financial aid. If so, you’re not alone.
In fact, just under one-third of our College Savings Survey respondents believe that savings in a 529 plan are not considered when a college determines financial aid eligibility. However, the relationship between 529 plans and financial aid depends on a few things, like who owns the plan, when withdrawals are taken and what type of aid you’re applying for. In most cases, your 529 plan will have a minimal effect on the amount of aid you receive and will end up helping you more than hurting you. There are also several steps you can take to increase your child’s eligibility for student financial aid.
Types of aid
All colleges that offer federal need-based financial aid require students to complete the Free Application for Federal Student Aid (FAFSA). Colleges will use information from the FAFSA to calculate a student’s Expected Family Contribution (EFC).
However, there are less than 200 colleges that use an additional form to calculate institutional award eligibility, called the CSS Profile.
A family’s assets will be counted differently on each form. For example, assets in a grandparent-owned 529 plan are not reported on the FAFSA, but students may be asked to include them in the CSS Profile.
Since there are so few colleges that use the CSS Profile and their requirements can vary by college, let’s focus on how a 529 plan can affect how much money you can get from the FAFSA.
The value of a 529 plan owned by a dependent student or one of their parents (529 plans do not allow joint ownership) is considered a parent asset on the FAFSA. About the first $10,000 will fall under the Asset Protection Allowance (the exact amount depends on the older parent’s age). Any parental assets beyond that amount will reduce a student’s aid package by up to a maximum of 5.64% of the asset’s value.
So, if a parent’s 529 account exceeds the Asset Protection Allowance by $10,000, his child’s financial aid award could be reduced by as much as $564. Of course, no one wants to lose $564, but the tax-free investment gains you’ve earned in your 529 account could likely outweigh this tiny loss. However, other student-owned assets are not treated as favorably. A custodial account under UGMA/UTMA, for example, will be counted as a student asset and will reduce the financial aid package by 20% of the asset value. So, in this case a $10,000 student asset means $2,000 less financial aid.
As mentioned above, assets in a 529 plan owned by a grandparent or other relative are not included on the FAFSA.
Any interest, dividends or capital gains generated from a student’s asset that are reported on their federal income tax return will be counted on the FAFSA. This income will be assessed at 50% when calculating EFC.
Earnings in a 529 plan, however, do not have to be reported on the FAFSA and will have zero effect on financial aid.
529 plan distributions are another area where the impact on financial aid will depend on the account owner. With a parent- or student-owned plan, 529 withdrawals used to pay for college will not be reported on the FAFSA. That means if you liquidate your account to pay for your child’s sophomore year, there will be no effect on a subsequent year’s FAFSA.
Grandparent-owned 529 Plans
The situation gets a little stickier when the account is owned by a grandparent or other relative. The student will have nothing to report on the FAFSA while the money is sitting in a grandparent-owned 529 plan, but any withdrawals used to pay for their college will be counted as untaxed income on the FAFSA. Untaxed income has the same impact on eligibility for need-based financial aid as taxable income.
Let’s say a grandmother wants to cover a full year of her grandson’s tuition at a private college, which costs $45,000. He’ll be a freshman in the fall, and he plans on applying for financial aid every year. On his first and second FAFSA, he’ll have nothing to report, but when he applies for federal aid for the third year in college (when he’s required to report prior-prior year income) his untaxed student income that was generated from Grandma’s gift may reduce his aid package by as much as $22,500 – Yikes!
How you can Minimize the Impact of a 529 Plan on Financial Aid
To prevent this from happening, Grandma can wait until January 1 of her grandson’s second semester of his sophomore year of college to pay his tuition, after he completed his last FAFSA. This, of course, assumes he is graduating in four years.
You could also transfer account ownership to the student’s parent, but then the funds would be counted as a parent asset and reduce the following year’s aid package by up to $2,538 ($45,000 x 5.64%).
A third option is to rollover the money from the grandparent’s 529 to the parent’s 529, one year’s worth of funds at a time. If you wait until after the FAFSA is filed to transfer the funds from the grandparent 529 to the parent 529, it won’t be reported as an asset on the FAFSA. You just have to be sure to spend they money before the next year’s FAFSA comes around. Also, be sure to open the parent 529 account in the same state as the grandparent 529, as some 529 plans have recapture rules when you roll over the funds to a different state’s 529 plan.
Other strategies to minimize the impact of your 529 plan on financial aid include:
- Keep 529 accounts in the name of the student or one of their parents.
- If possible, only withdraw from your 529 plan in the last two years of college, so the withdrawals won’t need to be reported on the FAFSA.
- Take advantage of federal or private student loans.
- Apply for scholarships, as your 529 account won’t impact on your child’s eligibility for merit-based aid.
- Investigate education tax credits you can claim to increase your tax refund or reduce your tax refund.
Upcoming Changes to the FAFSA
Starting with the 2024-25 school year, changes to the FAFSA will impact the relationship between your 529 plan and financial aid. Most notably, distributions from grandparent 529 accounts will no longer need to be reported on the FAFSA as untaxed income for the student. This is great news for grandparents looking to support their grandchildrens’ studies, as their 529 withdrawals will no longer impact students’ eligibility for needs-based financial aid.
Read this post for a full explanation of how the new FAFSA will remove roadblocks to grandparent 529 plans.
Another change we’ll see for the FAFSA is that the form will be streamlined, with fewer questions and more closely-aligned to the parents’ federal income-tax returns.
- Complete Guide to Financial Aid and FAFSA
- How to Help Pay for College Without Impacting Financial Aid
- Workarounds for Grandparent-Owned 529 Plans
- What You Can Pay For with a 529 Plan
- 7 Myths and Realities of 529 Plans