Does a 529 Plan Affect Financial Aid?

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Kathryn Flynn

By Kathryn Flynn

December 7, 2023

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.

Just under one-third of our College Savings Survey respondents believe 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 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. You can also take several steps to increase your child’s eligibility for student financial aid.

Applying for financial 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 Student Aid Index (SAI), which measures a family’s ability to pay for college. This was previously called “Expected Family Contribution (EFC)”.

Fewer than 200 colleges 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, families don’t report grandparent-owned 529 college savings plans on the FAFSA, but colleges may ask students to include them in the CSS Profile.

Since so few colleges 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.

Account Ownership

The value of a 529 plan owned by a dependent student or a parent (529 plans do not allow joint ownership) is considered a parent asset on the FAFSA. The first approximately $10,000 will fall under the Asset Protection Allowance (the exact amount depends on the older parent’s age). Any parental assets, such as a brokerage account, savings account, and other 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-owned 529 savings 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 earned in your 529 account could likely outweigh this tiny loss. 

However, other student-owned assets are not treated as favorably. For example, a custodial account under UGMA/UTMA will be counted as a student asset, reducing 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.

Assets in a 529 plan owned by a grandparent or other relative are not included on the FAFSA. Note that in the case of divorce, only the parent who provides greater financial support to the student files the FAFSA. If the other parent owns a 529 plan, it is not reported on the FAFSA.

Impact of 529 Plan Earnings

Any interest, dividends, or capital gains generated from a student’s asset reported on their federal income tax return will be counted on the FAFSA. This income will be assessed at 50% when calculating SAI.

However, earnings in a 529 plan do not have to be reported on the FAFSA and will have zero effect on financial aid.

529 Plan Withdrawals

Qualified 529 plan withdrawals are not reportable as student income, regardless of who owns the 529 plan account. These withdrawals are considered qualified distributions when used for qualified education expenses, such as tuition and fees, books and supplies, room and board, and other standard education or college expenses.

How Changes to the FAFSA Affect Grandparent-Owned 529 Plans

As previously noted, grandparent-owned 529 accounts are not reported on the FAFSA. In previous years, however, there was a disadvantage to grandparent-owned 529 plans in that distributions from these plans would count as untaxed income to the student on the following year’s FAFSA.

This is no longer the case starting with the 2024-25 school year. Distributions from grandparent 529 accounts – and from 529 accounts owned by any other relatives other than the parent filing the FAFSA – 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 grandchildren’s studies, as their 529 withdrawals will no longer impact students’ eligibility for need-based financial aid.

Read this post for a full explanation of implemented changes as part of the new simplified FAFSA.

RELATED: Estimate your financial aid eligibility here

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