Will Your 529 Plan Hurt Your Child’s Eligibility For Financial Aid?
The thought of paying for a child’s college education can send convulsions through any parent. Today is 529 Day, and these plans are a popular college saving solution, but the uncertainty of how the account will impact financial aid makes some hesitant to open a 529 plan.
You can only imagine my excitement (sad I know) when I saw a Facebook post from my high school friend and Jazzercise extraordinaire, Teresa. She was touting the benefits of having a 529 plan from firsthand experience and even correcting a misunderstanding about 529 plans’ impact on financial aid.
In her post, Teresa wrote about the importance of starting a 529 plan for your child. Her son, a brilliant future engineer, received partial financial aid and scholarships to college. The remaining amount of college expenses he owes will be fully covered by her 529 plan, making her son one of the few millennials that will leave college debt-free.
Most of the comments to her post were advocates of the 529 plan, but one of the posts initially was “anti-529 plan” due to concerns about the effect on financial aid, until Teresa, the 529 plan guru, came to the rescue and explained the effect of 529 plans on financial aid in a way that would make any financial planner proud. As I read her post and the comments, I realized that not everyone is aware that there are several factors that go into how a 529 plan affects a dependent child’s financial aid package. In general, how 529 plans are counted towards your child’s financial aid package depends on the financial aid form used, who owns the 529 plan, and your child’s college’s formula on how 529 plans are counted towards financial aid packages.
Financial Aid Form Used
My guidance to any parent with a child attending college is to ask your child’s college what financial aid forms are required. The Free Application for Federal Student Aid (FAFSA) form is the most used financial aid form, especially for college students seeking federal need-based financial aid. How a 529 plan is reported for dependent students and counted for financial aid typically depends on the owner of the 529 plan.
529 Plan Owner’s Effect on Aid
529 plan owned by a custodial parent. In general, on the FAFSA form, a 529 plan owed by the custodial parent(s) typically counts as an investment and it may reduce need-based aid by a maximum of 5.64% of the asset’s value. Teresa knew that depending on your income, your 529 plan may have no impact on your child’s financial aid package. Withdrawals from 529 plans used for qualified higher education expenses owned by the custodial parent are not typically reported as parent or student income. Since only a small amount of the 529 plan is counted and none of the withdrawals, custodial parent-owned 529 plans generally have the least impact on your child’s financial aid package. Typically, parents are one of the owners whose 529 plans get the most favorable treatments, so ideally the custodial parent should own the 529 plan.
529 plan owned by the non-custodial, non-married parent, living separately. 529 plans owned by the non-custodial parent are not generally listed on the FAFSA form. Once the funds are withdrawn, those funds are typically considered to be student cash support (untaxed income) on the FAFSA form. Up to 50% of the value of the student’s income (after allowances) could be part of the Expected Family Contribution (EFC, page 10). Consider funding a 529 plan owned by the custodial parent or (if your 529 plan allows) transfer ownership to your college-bound child since a 529 plan owned by a child is considered a parental asset and gets the more favorable treatment on financial aid forms.
529 plans owned by relatives and friends (grandparents, aunts, etc). 529 plans owned by anyone who is not a custodial parent follow similar rules. The 529 is not counted as an asset on the FAFSA form, but like non-custodial parents, withdrawals from the 529 plan are counted as student non-taxable income and up to 50% of the value of the withdrawal could impact financial aid. If you are a relative or family friend with a 529 plan for a child, consider waiting until the child files their last FAFSA form to withdraw the funds from the 529 plan.
by Tania Brown, Forbes.com, May 29, 2016
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