529’s and Financial Aid

Putting your children through college is not cheap. Using my own state of Massachusetts as an example, University of Massachusetts Amherst, a popular state school costs $30,790 per year for in-state students. This covers tuition/fees and room and board. A popular private option, Boston College, costs between $69,500 and $71,100 per year for tuition/fees and room and board. And it’s only getting more expensive every year, with college cost inflation outstripping regular inflation. It’s no wonder that families are motivated to save for college early and concerned about financial aid.

The best way to save for college is through a 529 plan, which are college savings plans set up to provide tax-advantaged ways to save for college. You may receive a state income tax deduction for a portion of your contribution depending on where you live, your contributions are invested and grow tax-deferred, and when you make withdrawals for qualified education purposes those withdrawals are tax-free. Given the costs highlighted above, a common question is how 529 plans will impact a student’s eligibility for financial aid. Parents I work with want to responsibly save for their kids’ college tuitions, but they do not want to miss out on an opportunity for the schools to reduce the potentially exorbitant cost of college.

This week we have a guest post by Eric Stutman, the founder of Top Choice College Consulting, addressing this very topic.

Who owns a 529 plan can dramatically affect college financial aid

529 plans, named after section 529 of an Internal Revenue code, are a popular way for families to save money for college because contributions grow tax-deferred and distributions are tax-free when used for qualified higher education expenses. In addition, some states allow some of the contributions to be deducted from the parent’s taxable income. However, the ownership of the plan can dramatically affect a student’s financial aid eligibility.

Case 1 (most common and most desirable): Parent-owned 529 plan

In this case, the funds in the 529 plan are listed as part of the parent’s investments (question #89 on the FAFSA form). The government (and colleges) will expect families to contribute approximately 5.64% of this and other parent-owned assets towards college each year.

Case 2: Student-owned 529 plan

In this case, the funds in the 529 plan are listed as part of the student’s investments (question #41 on the FAFSA form). The government will expect families to contribute approximately 20% of this and other student-owned assets towards college each year.

Case 3: Grandparent or other relative-owned 529 plan

In this case, any distributions of the funds from the plan to pay for college are listed as part of the student’s untaxed income (question #44i on the FAFSA form). The government will expect families to contribute approximately 50% of this and other student income towards college each year.

Note that Cases 2 and 3 are not ranked in terms of desirability because depending on your situation, one could be more advantageous than the other. Since distributions from grandparent-owned 529 plans are listed as part of the student’s untaxed income, it is not wise to use them early on in college because of the expected family contribution that would result. However, until they are used they are not counted at all, so they can be more beneficial than a student-owned 529 plan in the third or fourth year of school when these distributions will no longer appear on the FAFSA form.

For grandparent owned 529 plans, it’s worth a review with your children and their advisor to see if for financial aid purposes the account would be better off owned by the parents, assuming the grandparent is willing to give up control of the account.

Therefore, we recommend that parents own a 529 plan whenever possible. If a grandparent owned plan already exists, it can be renamed or rolled-over. Alternatively, distributions can be made after college to pay, reduce or eliminate student debt, or made towards the end of the student’s college years when these distribution will no longer appear on the FAFSA form.