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How Do 529 Plans Affect Financial Aid?

The Grandparent Loophole

If a grandparent or non-custodial divorced parent owns the 529 account, you don't have to report it as an asset on the FAFSA at all. 3 You may be tempted to exploit this loophole, but there's another consideration, according to Mark Kantrowitz of FinAid.org. 4 You'll have to report each 529 distribution as student income instead, and the federal government counts 20 percent of that as an EFC.

That's much worse than the 5.64 percent that's counted if the parent or dependent student owns the account and you report it on the FAFSA.2 This FAFSA reporting problem becomes a non-issue if the funds are used to pay for the final year of school.

"The other reason for putting the 529 account in the parent's name and not in a grandparent's is it keeps it from being taken to pay for long-term care expenses if the grandparent were ever to enter a nursing facility," Hurley adds.

Of course, grandparents and other family members can still set up 529 college savings programs for children — it's just best from a need-based aid standpoint to set them up with the parent or child as the account owner, says Mark Kantrowitz, founder of the Web site FinAid.org.

State and College Financial Aid Programs

State and college financial aid programs have their own rules for how 529 savings affect need-based aid.2 For example, in Illinois (State College Savings Bond Program), Indiana, Kentucky, New York, Pennsylvania and Virginia, your 529 savings don't affect your child's eligibility for state need-based aid at all.4 Check with your state or college to find out more.

Private Schools

Private schools typically have their own forms and methodology for calculating need-based aid. They are more likely to ask about overall family assets, including 529s and other resources and factor them in to the financial aid profile.

529 Distributions

529 distributions have financial aid advantages, too. When you take money out of a 529 account to pay for college, you won't have to count it as income on next year's financial aid application. 2

"This exclusion provides 529 plans with an advantage over mutual funds and other taxable investment accounts that must be tapped for college," says Hurley at savingforcollege.com. 2

In Summary

You're always better off if you've saved for college, regardless of its effect on need-based aid, says Kantrowitz at FinAid.org. "If you're talking about 529 versus a taxable account, there's no benefit to having [college savings] in a taxable account other than the ability to spend it on other things," Kantrowitz says. "If you're talking about saving for college versus spending the money on vacations, the family that saves will have more college choice and flexibility, and a 529 plan is one of the best ways to save."

Finally, "remember that most financial aid comes in the form of loans, not grants, and so you end up paying it back anyway," warns SavingForCollege.com. 2 Saving is much cheaper than borrowing, Kantrowitz points out: You may pay twice as much for college in the long run if you pay for it with loans instead of savings.

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1 Assets include money, investments, certain business interests, and real estate, based on a sliding income scale and after certain allowances. Beginning in 2009–2010, a 529 account in a dependent student's name is considered an asset of the parents.

2 SavingForCollege.com, 2010, Does a 529 Plan Affect Financial Aid?

3 FinAid.org, 2010, Section 529 Plans , Mark Kantrowitz

4 FinAid.org, 2010, Account Ownership: In Whose Name to Save? , Mark Kantrowitz


This information is written in connection with the promotion or marketing of the matter(s) addressed in this material. The information cannot be used or relied upon for the purpose of avoiding IRS penalties. These materials are not intended to provide tax, accounting or legal advice. As with all matters of a tax or legal nature, you should consult your own tax or legal counsel for advice.

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