Parents can help ease the burden by saving for college costs early, and a 529 college savings plan rewards them for it with tax deductions and potential investment growth.
Parents, students, and other supporters who plan to open or already have opened a 529 account should understand the impact the account has on a student’s eligibility for financial aid. Set it up properly — or make adjustments if you have to — to avoid hurting a student’s chances at federal funds when tuition bills come due.
A 529 plan is a tax-advantaged investment account designed to pay for college. The name comes from the section of the IRS code that dictates its tax implications.
The plan can be either a:
A 529 plan is similar to but not synonymous with an education savings account (ESA), which allows broader use of funds, includes an income restriction, and limits contributions.
Anyone can take out a 529 plan for any student. That includes parents, grandparents, parents’ siblings, and friends. How the plan affects a student’s financial aid when it comes time to pay for college depends on who owns the plan.
A 529 college savings plan can be a smart way to save and invest money for college because:
One drawback of having a 529 savings plan is that it can affect your eligibility for public financial aid, including scholarships, grants, and federal student loans.
You have to report a 529 college savings plan or prepaid tuition plan on a free application for federal student aid (FAFSA), the form students submit to apply for grants, work-study, and loans from the U.S. Department of Education.
How a 529 plan affects financial aid eligibility depends on who owns the account.
The assets you report on a FAFSA contribute to the expected family contribution (EFC) calculation to determine financial aid eligibility. Students can expect to contribute up to 20% of their financial assets, and parents can expect to contribute up to 6%.
You’re best off if the 529 account is in the parents’ or dependent student’s names. That allows you to report it as a parental asset, only 6% of which is expected to be used to pay for college.
In any other situation, the money in a 529 account could count as a student asset and be subject to the 20% expected student contribution, which could reduce how much need-based financial aid the student is eligible to receive.
A 529 plan doesn’t affect eligibility for private student loans. Private lenders determine eligibility for loans based on the borrower’s ability to repay, not on their ability to contribute to education costs by other means.
The FAFSA doesn’t determine a student’s eligibility for scholarships, so reporting a 529 on that form doesn’t affect scholarships you could receive.
A few colleges and scholarship programs require students to apply for scholarships with a CSS Profile, which could include 529 account information.
However, your 529 plan value only affects need-based scholarships, so apply for scholarships that use other criteria — such as academic achievement — if you’re concerned about eligibility.
Plan, if you can, to keep a 529 plan from hurting a student’s financial aid eligibility in the future.
A custodial parent should open the account in their name or the student’s name from the start. Anyone can make a third-party or gift contribution, so grandparents and other supporters can still make tax-deductible contributions to help pay for the child’s education.
If a grandparent or someone else already has a 529 account in their name, they can transfer the plan to a parent’s or student’s name before distributions begin.
Check the plan’s terms before transferring, though. Some plans handle transfers in a way that makes the amount taxable, and some don’t allow transfers at all. In either case, you could first rollover the plan into a new 529 account (similar to a retirement plan rollover), then transfer ownership.
If a grandparent or someone else has a 529 account in their name and doesn’t transfer ownership, wait until later in the student’s college career to take distributions. The student can take distributions in the last year or last semester when they won’t file a FAFSA for the following year.
A 529 college saving or prepaid tuition plan is a smart way to prepare for college expenses and reduce your student loan debt, especially if you start saving long before college begins.
Because a 529 account is money you can put toward education costs, it affects what kind of financial aid a student is eligible to receive or borrow from the government. You can mitigate this effect by understanding how to account ownership and distributions affect eligibility. Your best bet is to put the account in a custodial parent’s name or the student’s name.
The earlier you open a 529 account, the longer you have to build savings and earn interest before a student goes off to college. You can always withdraw the principal without penalty, so it’s not lost money even if the beneficiary doesn’t attend college.
If you start it when the student is very young, you may be able to save enough — without a heavy financial burden — to cover the cost of college without even tapping into financial aid.
Do you have a 529 plan for a student? What can you do to mitigate the effects it will have on their financial aid?