Could a 529 Plan Mess Up Your Child’s Financial Aid?

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529 AccountAs you work to save up enough money to send your child to college, one of the tools at your disposal is the 529 plan.

This plan allows you to put money to work on behalf of your child. With a 529, money grows tax-free — as long as it is used for qualified education expenses.

But could the 529 be a little too effective? What happens if the account grows just enough that assets affect eligibility for financial aid? Depending on the situation, the 529 might be good enough to help out, but not quite enough to completely cover the costs. But if there is too much in the account, you could lose some of your  ability for the financial aid you need.

Who Owns the Account?

According to Travis W. Freeman, Certified Financial Planner and President of Four Seasons Financial Education, the real question is who owns the account. “If a parent owns assets such as cash or stock, these parental assets are assessed at an amount of 5.64% toward aid eligibility,” he explains. “However, if the same cash or stock is owned by the student, it will be assessed at an amount of 20%.”

“In other words,” Freeman continues, “if a parent owns the assets, less will be considered ‘available’ for college, thus increasing the chances of receiving aid. If
possible, a child should not be the owner of any assets that may be meant for college.”

Set up the 529 account so that you own it, but your child is the beneficiary. And be careful about what assets you transfer into the 529. Assets from your child’s  savings account and other custodial accounts that are moved into a 529 still “count” as theirs, so be aware of that.

Another scenario to watch out for is if neither you nor your child owns the account. “Distributions from a 529 plan may have an impact on Financial aid, especially if the 529 owner is not the college student or the parent,” says Peter Donohoe, Certified Financial Planner and Wealth Manager at PRW Wealth Management. “This most often occurs when a Grandparent opens a 529 for the grandchild.”

“A 529 registered in the name of a Grandparent for the benefit of a grandchild should not show up on the first financial aid application the grandchild completes before attending college,” Donohoe continues. “Once a distribution is made from the 529, the distribution does get included as income to the grandchild on the next financial aid form they complete for the following school year.”

Once the income is considered the grandchild’s, it counts heavily against eligibility for financial aid. Donohoe suggests that the 529 account ownership be changed from the grandparent to the parent in order to avoid this issue. Another possibility, he says, is to “wait until junior year to access the 529 for college expenses. By waiting until after Jan 1 of junior year, you will most likely avoid having the income show on the last FAFSA form the grandchild completes.”

Bottom Line

Freeman and Donohoe agree that a 529 is one of the best ways to save money for college. While the account will affect the asset count no matter what, the best way to cushion the blow to aid, though, is to be aware of how ownership of the account affects aid, and assign ownership in the most advantageous manner.

Image: Alex Guerrero

{ 8 comments, please add your thoughts now! }

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8 Responses to “Could a 529 Plan Mess Up Your Child’s Financial Aid?”

  1. admiral58 says:

    I have them set up for my children. A great vehicle to save.

  2. Mike says:

    Very usefull article!!!

    Thank You.

  3. It figures that what you think might be helpful might not be. Thanks for making it clear that the parent should retain ownership.

  4. Granddad Kek says:

    I have had trust funds, and then 529 accounts when they became available, for my seven grandchildren and a great-grandchild. The oldest two of the seven did not seek financial aid thanks to favorable stock markets and went on to gain graduate degrees. They are debt free. The third has had the misfortune of applying for financial aid in the face of the recent economic crisis. Although the parents are devoted social workers, they are in no position to afford a college whose de facto annual costs are some $65K. Granddad’s $125K 529 had shrunk to $100K, which was declared. Armed with fine grades and recommendations, 800/740 SATs, five 5s in demanding science/math AP courses, sports and meaningful extracurriculars, and pre-med determination that included EMT participation and certification, admission offers came from three prestigious private colleges and universities, none offered financial aid; Granddad was the financial aid
    at about the same level the school offered other applicants. Where did the applicant go? A fine state university with a pre-med honors program that already has included physician-shadowing and admission to numerous events in its medical school, a modest tuition waiver, and perks that include attractive housing in new dorms with similar serious students and early course registration. Assuming the honors program culminates in a B. S. after three years (optional), and with the economic recovery not stalling, there might be enough left in Granddad’s piggy bank for two years of medical school. Fortunately, parents of 3/4 of my other grandchildren will likely be able to finance their children’s educations so I will now concentrate on 1/4 and great-grandchild but make sure savvy strategy is used this time.

  5. SA4H says:

    It’s always recommended that you should take care of your retirement account first before contributing to your child 529 account.

    In another word, those qualify to contribute to Roth IRA should max this out first; the same apply for those have a 401k with matching % from employer. Even standard 401k funding should take top priority, over 529 contribution.

    The simple argument is this: You can always use your retirement account (borrow/take distribution/etc) to help your child pay for their education when needed. On the other hand, you can NOT use the 529 account for your retirement. This is the most important aspect.

  6. freeby50 says:

    I don’t think many people would put a 529 in their kids name, that wouldn’t be typical. However its a good point that grandparents can unintentionally hurt the financial aid. I bet a lot of people wouldn’t see that coming.

  7. Shafi says:

    I may have said this before. When my son started college, I advised him to meet with his adviser and set up a schedule so that he can go to school one semester and the next he works. Who says you must finish 4-year college in 4 years. He’ll be finishing it in 7 years but along the way he’s getting good experience. The company has promised (but only verbally) that once he graduates, he’ll be preferred for a permanent job over others. Hopefully he’ll graduate with not a single penny in student loans.

  8. JoeTaxpayer says:

    It seems to me the advice of saving for college results in shooting oneself in the wallet.
    If I could do it over, instead of saving for college, I’d have paid off the mortgage, and taken any extra money (beyond the retirement savings) to convert pretax to Roth. Then, planned to retire a year before she enters college. With no income and living off Roth the first years, we’d maximize aid. Just like the convoluted tax code, college cost is a game to be navigated.

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