Understanding the Impact of 529 Plans on Financial Aid: What You Need to Know

When considering the best strategies for saving for college, the impact on financial aid awards can be a crucial factor. A popular savings method, the 529 plan, can indeed affect the amount of financial aid a student may be eligible for. Understanding how 529 plans are viewed in the eyes of the financial aid system can help families make more informed decisions about their college savings strategies.

Does a 529 Plan Impact Financial Aid?

Yes, a 529 plan can indeed impact financial aid. However, the degree to which it impacts financial aid eligibility is surprisingly low, especially when compared to other savings methods.

Owned by the Student or Their Parents

When a 529 plan is owned by a dependent student or the student's parent, it is reported as a parent asset on the Free Application for Federal Student Aid (FAFSA). This reduction in eligibility for need-based financial aid is capped at a maximum of 5.64% of the 529 account balance. For example, if a student or their parent saves $10,000 in a 529 plan, the need-based eligibility would be reduced by a maximum of $564. This is significantly less than the $2,000 reduction that would occur with $10,000 in a savings account.

Owned by Grandparents, Aunt, or Uncle

On the other hand, if a 529 plan is owned by someone other than the student or their parent, such as a grandparent, aunt, or uncle, it is not reported as an asset on the FAFSA. Instead, distributions from the 529 plan will be considered untaxed income to the student, reducing financial aid eligibility by half of the distribution amount.

For instance, if a grandparent withdraws money from a 529 plan for a student, and the distribution is $4,000, the student's financial aid eligibility would be reduced by $2,000. This method can be particularly advantageous for grandparents or other family members who want to support a student's education without significantly impacting their financial aid package.

The 529 Plan and Full-Ride Scholarships

While most full-ride scholarships are conditional on athletic or need-based financial need, the impact of a 529 plan can still play a role. If a student is awarded a full-ride scholarship based on need, that scholarship value would be included in their Expected Family Contribution (EFC). This means that any funds in a 529 plan could impact the student's eligibility for need-based scholarships.

For example, if a student is awarded a full-ride scholarship based on financial need and has a $10,000 529 plan, the $564 reduction in need-based eligibility could impact the award or even cause a student to lose the scholarship altogether. However, it is important to note that this scenario may vary by institution, and it's wise to check with the financial aid office of each school.

Strategies for 529 Plan Owners

To make the most of a 529 plan while minimizing its impact on financial aid, there are a few strategic options:

Save in the Parent's Name

If you or your parents are the owners of the 529 plan, be aware that the plan is considered a parent asset on the FAFSA, leading to a lower reduction in financial aid eligibility. This can be more advantageous than saving in your own name, as distributions from your 529 plan would be considered untaxed income, reducing eligibility by half of the distribution amount.

Consider Grandparent Ownership

If you want to involve grandparents in the savings process, consider transferring the 529 plan ownership to a grandparent. In this scenario, the 529 plan is not reported as an asset, and distributions would be considered untaxed income to the student, reducing financial aid eligibility by the full amount of the distribution. This can be a win-win, as the grandparents can benefit from the tax advantages and help reduce the financial burden on the parents.

Timing Your Withdrawals

If you plan to withdraw money from a 529 plan to cover college expenses in a given academic year, you might consider doing so after your FAFSA submission. This can help minimize the impact of distributions on your financial aid package for that year. However, it is important to know that the income from distributions might affect other types of financial aid, such as grants and scholarships.

Conclusion

While the 529 plan can have an impact on financial aid, the impact is relatively limited, especially when owned by parents. By understanding the rules and utilizing strategic planning, families can maximize their college savings and minimize the impact on financial aid packages. Whether you save in the parent's name or involve grandparents, the key is to plan ahead and understand the nuances of the system.