529s and Financial Aid (Script)

By: Savingforcollege.com

Q:

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 Watch Video

A:

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


Learn more about 529s and financial aid.

Popular Questions

Question

Two kids, two 529 plans?

Dear Big Bill,
While it's possible to maintain a 529 plan in just one child's name, even when you intend to send more than one child to college, I generally recommend that families open a separate 529 account for each child.

That's assuming there is no additional cost to maintaining multiple accounts. If your 529 plan charges an annual or quarterly account maintenance fee, check to see if you can avoid the fee by signing up for automatic contributions through payroll deduction or electronic funds transfer)

With a separate 529 plan for each child, it becomes easier for you to tailor the mix of stocks, bonds and stable-principal investments (e.g., stable value, guaranteed principal and money market funds) to the particular ages of your children. When your older child is nearing high school graduation, you may want to ratchet down the level of market risk in her 529 plan. At the same time, you could keep a more-aggressive asset allocation in your younger child's 529 plan, accepting more risk for a potentially higher return. Many 529 plans offer "age-based" investment options that automatically make these adjustments as the beneficiary ages.

Separate accounts for your children also offer more gift-tax leeway. Since your 529 contributions are treated as gifts from you to the account beneficiary, your $15,000 (in 2018) annual gift exclusion will go twice as far with two accounts -- one for each child -- than with just one account.

Financial aid is another reason to recommend maintaining separate accounts. You wouldn't want the investments reserved for your younger child's future college expenses to count against your older child's financial aid eligibility. Be warned: The rules here are rather murky, and the impact of a sibling's 529 account may depend on the college's own policies as well on as the type of aid -- federal or institutional -- being sought.

Finally, I believe that separate 529 accounts allow for better family bookkeeping. There will never be any doubt as to your intention to help send all of your children to college. You'll avoid the uncomfortable position of being asked to explain to a curious 8th-grader why account statements are showing up in the mail with only a brother or sister's name on them. And in the event of your death or divorce, no matter how unlikely, your legal representatives and other family members will have less reason to question your actions in setting up and funding the 529 plans.

Even with separate accounts, you'll continue to have the flexibility to shift the money around in the future. You simply need to make sure that whenever funds are withdrawn from the 529 plan to pay for college they are coming from an account in the name of the child incurring the costs. It's a simple matter to change the beneficiary designation among family members at any time, transfer 529 funds between different family members' accounts or split one 529 account into two. The ability to move assets around the family is a key advantage of 529 plans when comparing other college-savings alternatives, such as Uniform Transfers to Minors Act, or UTMA, accounts.

Original Post: 2005-10-13
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Coverdell ESA vs. 529 Plan: Which to choose? (Script)

The Coverdell ESA and the 529 plan are both excellent college savings vehicles because they are both tax-free when used for college. But many families face a choice: do they use a 529 plan for all of their child's college savings, or do they use a Coverdell for the maximum amount of $2,000 each year and put any any extra savings above $2,000 into a 529 plan? In spite of its low annual contribution cap, Coverdell's are now attracting quite a few families. There are two major reasons for that. One is that only the Coverdell allows you to self-direct your investments, just like you might self-direct the investments in your IRA. The other is that in addition to college expenses, Coverdells can be withdrawn tax-free to pay for a broad range of K-12 expenses, while 529 plans are limited to K-12 tuition. This feature is appreciated most in families planning to send their children to private grade schools, which may include additional costs such as room and board or uniforms. A 529 plan, on the other hand, does not impose age limits or income limits like the Coverdell does and so overall we see a lot more money going into 529 plans than into Coverdells. Plus many savers are happy with the investment choices offered by the 529 plans and don't necessarily want to self-direct their investments. And don’t forget this: your state may be giving you a state tax deduction for using a 529 plan, but there are no states offering a state tax deduction for investing with a Coverdell ESA.

Learn more about Coverdell ESAs.

Original post date 2013-07-15
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Top 529 Plan Withdrawal Tips. (Script)

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Top 529 Plan Withdrawal Tips. (Video)

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