Spring can be a busy time of year, especially for families with high-school seniors ready to take the next step to college. In addition to thinking about college acceptance letters, parents (and grandparents) should be thinking about how a 529 account can help pay for college when your child or grandchild may qualify for some level of federal financial aid.
All colleges offering federal need-based financial aid require students to complete the Free Application for Federal Student Aid (FAFSA). Colleges use information from the FAFSA to determine a family’s assets, including a 529 account, to calculate a student’s Expected Family Contribution.
A 529 account owned by a dependent student or by parents is included as an asset on the FAFSA. A grandparent-owned 529 account is not included as an asset on the FAFSA. However, any distribution to pay for college could have a major impact on the student’s financial aid eligibility. For example, if the value of a student or parent-owned 529 account exceeds the Asset Protection Allowance, then the student’s financial aid award could be reduced by 5.64% of the 529’s value.
On the other hand, a withdrawal from the grandparent’s 529 account to pay for college could reduce the student’s financial aid by 50% because the withdrawal is counted as income to the student the next time a FAFSA is filed for financial aid. This disparate impact is simply a result of how the FAFSA treats 529 account distributions.
The good news is there are planning strategies that can help mitigate this potential impact while coordinating grandparent-owned 529s and financial aid effectively. Here are some helpful 529 planning strategies:
- Change account owner. If the 529 plan allows, the grandparent can change the account owner to the parent. This will minimize the reduction in financial aid the next time you file a FAFSA. Check to see if your state will recapture state income tax benefits if you change the account owner.
- Rollover 529 plan funds. Grandparents can roll over a year's worth of funds to a parent-owned 529 plan. If the rollover occurs after the FAFSA is filed, the funds won't be reported as an asset on the FAFSA (assuming the funds are spent before the next FAFSA is filed). Distributions will not affect aid eligibility because the 529 plan is owned by the parent. It’s important to note, the parent-owned 529 plan should be opened in the same state as the grandparent-owned 529 plan to avoid recapture rules when funds are rolled over to a different state’s 529 plan.
- Take a distribution later. If the student will graduate in four years, grandparents can wait until January 1 of the student's second semester of their sophomore year in college to take a distribution, after the student has completed his/her last FAFSA. This is because the FAFSA uses the prior-prior year’s income and tax information to calculate eligibility. If the student will graduate in five years, families should wait until January 1 of the student’s junior year to take a distribution.
Financing the cost of higher education and using 529s as a savings tool can be complicated. However, there are a number of strategies when it comes to coordinating 529 plans that can be helpful. To learn more about how we can help you meet your financial goals, like financing the cost of higher education or help coordinate the use of 529 plans, schedule a call today.
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