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Are Financial Aid Calculations Hurt by a 529 Plan?

May 31, 2012

When families want to save for their child's future college education they often set up 529 plans with their child as the beneficiary. Money put into these accounts grows tax-free and can be used to pay education expenses later. But having a 529 does reduce how much financial aid a student receives, only the benefit of tax-free interest will supersede the drawbacks most of the time.

Everyone wanting financial aid must start with the Free Application for Federal Student Aid (FAFSA). According to the information given about student and parent income and assets, the government calculates the Estimated Family Contribution (EFC). If the EFC is less than the price of attending college, the student can obtain need-based financial aid, such as grants, scholarships and loans. The lower the EFC, the more financial need a student has. Students also can get unsubsidized loans even if they do not qualify for need-based aid.

When one of the student's parents is the owner of a 529 plan, it is reported as a non-retirement parent asset on the FAFSA. The EFC calculation includes no more than 5.64 percent of the parents' assets each year. Depending on the value of the parents' assets, they might not count at all toward the EFC. Therefore, the 529 could slightly affect the student's aid eligibility. For example, if the 529 account has $30,000, it will increase the EFC by no more than $1,692.

A 529 plan that lists the student as the beneficiary but has an owner other than the student's parents does not get listed on the FAFSA at all. However, distributions from the 529 plan for the benefit of the student each year will appear on the FAFSA the following year as student income. The EFC formula usually includes 50 percent of student income, so 529 distributions will have a significant effect. For example, if a grandparent gives a student $6,000 from a 529 plan one year, this will add about $3,000 to the student's EFC the following year. One way to avoid this problem is to wait until the last year of college to take any distributions.

Institutions other than the federal government set their own rules on how to consider 529 plans when awarding state or college-based financial aid. For example, many private schools require students to submit a CSS Profile, which asks for a list of all 529 plans on which the student is the beneficiary, even if the parent is not the owner. Therefore, the school might reduce a student's eligibility for institutional grants if the student has a lot of money available in 529 plans.

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