FINANCIAL AID IMPLICATIONS OF SECTION 529 PLANS

The savings and prepaid tuition plans authorized by section 529 of the Internal Revenue Code (usually called 529 — or section 529 — plans) can be a great tool for college savings. They offer a handful of solid choices for investing your funds, usually provide a decent return (especially under the prepaid tuition model) and are unparalleled among other college savings options when it comes to tax advantages. In spite of all the advantages a 529 college savings plan can offer, a family who still needs or hopes to receive some form of financial aid must plan their use of a 529 account wisely. The amount in and the ownership of a section 529 has a direct impact on the amount of aid a student is eligible to receive.

Use 529 College Savings Accounts First
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As good as it felt to squirrel away all that money for college, if you didn’t save enough tough to cover all four years, use it up first. In most cases, 529 accounts are owned by parents for the benefit of their children. This means that they are accounted against aid eligibility at a rate of just under 6 percent. If you spend it all in the first year, it won’t be there to count against aid eligibility over the next years of college.

The problem you run into with a 529 account and other aid is that if you do receive some form aid, such as a scholarship, you are only able to withdraw the difference between the aid and the actual college expenses. Otherwise you get hit with a tax penalty, which flies in the face of the whole idea behind the accounts.

In order to qualify for a tax-free withdrawal, you have to use your 529 savings at a school that is otherwise eligible to receive federal financial aid funds. You can only spend the money in one of the following expense categories:

– Tuition and Fees
– Books
– Room and Board, for students enrolled half-time or more
– Equipment and supplies required for enrollment
– Computer equipment and supplies

Thus, if you have it, spend it.

Or Use 529 College Savings Accounts Last

One effective way to minimize how a 529 account affects financial aid eligibility is to make sure they are owned by neither the student nor her parents. So, for example, if a grandparent is the account holder on behalf of the student beneficiary, the 529 account will have no effect whatsoever on aid eligibility. In the eyes of FAFSA and the expected family contribution calculation (EFC), it’s as though the 529 account doesn’t exist. Which is great… until you want to use it. Once a grandma makes a withdrawal to pay for Junior’s college tuition, the money taken from the 529 savings plan becomes income attributable to the student. This is not good.

Student income is the asset that is most heavily weighed against financial aid in the EFC calculation. After an allowance of around $6,000, fully half of anything a student makes is expected to go toward college expenses. So, grandma’s good will becomes a bit of a thorn in Junior’s financial aid side.

If the grandparent-owned 529 plan is not enough to cover all four (or however many) years of college, then you should not tap into the funds until AFTER you have submitted your FAFSA for the last year of school. In this way, the student will receive the fullest consideration for financial aid, as well as the greatest benefit of his grandparents’ generosity.

For parents, or in some cases students themselves, who have already set up a 529 savings plan, it may be possible to change the plan’s ownership. You have to do so before the beneficiary is of college age and begins school. Moreover, you absolutely, positively, should not change the ownership of your 529 savings account without talking to the plan administrator and your own financial advisor. The potential ugly tax consequences of getting it wrong far outweigh any benefits you would gain from an additional 6 percent of eligibility toward financial aid.…