529 Plan: Ownership and Student Aid Impact

||  This article is part of a series on the 529 Education Savings Plan  ||

In the previous article, I discussed how an estate planner could potentially use a 529 Education Savings Plan to unload a significant sum of money without tax consequences.  But what are the consequences if you find yourself or your children on the receiving end of a 529 Plan?

How 529 Plan assets and withdrawals affect the beneficiary's student financial aid eligibility depends on who owns the Plan.

This table tells the story:

Who Opened The Account? How are the plan's assets considered? plan withdrawals?        
Student (Dependent) parental asset (-5.6%) ignored; no effect
Student's Parent parental asset (-5.6%) ignored; no effect
Student (Independent) student asset (-20%) ignored; no effect
Grandparent or Other ignored; no effect student income (-50%)

The numbers listed are the percentages by which the student's aid eligibility will be reduced by the plan's assets or by withdrawals from the plan.

The asset value of a 529 Plan owned by a grandparent or other non-custodial individual—including a non-custodial parent in a divorce situation—is not taken into consideration when calculating student aid eligibility using the Free Application for Federal Student Aid (FAFSA); however, when the student makes a withdrawal from this account, the value of the withdrawal beyond a small annual allowance is reportable on the following year's FAFSA as student income, which reduces aid by 50% of the withdrawal amount.  This is the situation regardless of whether the withdrawal follows 529 Plan rules concerning qualified education expenses and the withdrawal is therefore nontaxable.

A Caveat

The rules described above are used by the federal government on the FAFSA.  For a school's own internally-managed financial aid, the school's aid office may ask for different information and may use different calculations than the FAFSA.  Talk to your intended school's aid office for complete details.

Potential Strategies

Because a withdrawal is only reflected on the following year's FAFSA, one viable strategy is to use the grandparent-owned 529 Plan only to pay for the last year of college.  The student won't be applying for more aid the following year, so these withdrawals would have no negative effects.

Many 529 Plans also offer you the option of changing the account owner to the dependent student or the student's parents.  If your plan doesn't offer this, you can first roll over the money into a different state's plan that does allow account owner changes.  See the list of states that offer account changes, read about the effects of a 529 Plan rollover, and find the best 529 Plan for your situation.

The Laws

The 529 Plan effects above are primarily the result of these two laws:

The College Cost Reduction and Access Act of 2007 (CCRAA) (P.L. 110-84)
"no distribution from any qualified education benefit described in subsection (f)(3) that is not subject to Federal income tax, shall be included as income or assets in the computation of expected family contribution for any program funded in whole or in part under this chapter"

The Higher Education Act of 1965, Subsection 480(f)(3)
"A qualified education benefit shall be considered an asset of —
(A) the student if the student is an independent student; or
(B) the parent if the student is a dependent student, regardless of whether the owner of the account is the student or the parent."

With these rules in mind, you should be able to maximize your education savings while minimizing any negative impact on federal student aid.  Happy saving!