Quite often now, I am having discussions with parents whose kids are about to enter college.   Many have been diligent about saving in their 529 College Savings Plans.   One of the advantages of a 529 Plan is that it accumulates on a tax deferred basis and can be withdrawn tax free if used for qualified education expenses.

Another advantage of a 529 Plan is that it reflects better when applying for needs-based aid through the Free Application for Federal Student Aid (FAFSA).   If the account is owned by the parents for the benefit of the student, it is considered a parental asset and for most people will only count against financial aid at a rate 5.64% of the account value. (1)  On the other hand, if you saved for college in a custodial account (UGMA/UTMA); those assets would be considered a gift and a child asset.   Children’s assets could reduce your needs-based aid package by as much as 20% of the account value. (1)

And what happens if Grandparents get into the mix? 

The rules are different for a non-parent owned 529 Plan.  If you are not careful, well-intended grandparents can royally mess up their grandchild’s financial aid.   Here’s how:

Let’s say college costs $50,000 per year and Grandma wants to pay for one year out of the 529 she created for her grandson.   We still have the same taxation rules as parent-owned 529 plans upon distribution (tax-free for qualified education expenses).  And for the year that Grandma’s 529 paid for her grandson’s tuition; his financial aid will not be affected.  

However, you need to re-apply with FAFSA every year throughout college.   The money from a non-parent owned 529 (Grandma’s 529) paid to the college is considered untaxed income to the beneficiary.   Untaxed income is assessed at a rate of 50% against need-based aid! (1)  So, the following year, when the grandson fills out the FAFSA, his aid could be reduced by up to $25,000 due to Grandma’s contribution. 

If money is coming from a variety of sources, what should a person do to ensure they don’t screw up their financial aid?

As some of these funding issues come up, we often bring in experts in navigating the federal financial aid program.   In the past, I have used an outside organization called College Inside Track.   They have a variety of college preparation programs.  But, for the purposes of maximizing financial aid, they are very comfortable being our back-office support to address specific client questions. 

There are ways for Grandparents to still contribute toward college and not screw up financial aid for their grandchildren (even from their own 529 Plans).   But it is important to talk to the experts to understand how to avoid costly mistakes.

• • “Yes, 529 plan will affect financial aid”, Kathryn Flynn, March 14^th, 2018, CollegeSavings.com

A 529 plan is a tax-advantaged investment program designed to help pay for qualified education expenses.  Participation in a 529 plan does not guarantee that the contributions and investment returns will be adequate to cover education expenses.  Contributors to the plan assume all investment risk, including the potential for loss of principal, and any penalties for non-educational withdrawals.

Your state of residence may offer state tax advantages to residents who participate in the in-state plan, subject to meeting certain conditions or requirements.  You may miss out on certain state tax advantages should you choose another state’s 529 plan. Any state based benefits should be one of many appropriately weighted factors to be considered in making an investment decision. You should consult with your financial, tax or other advisor to learn more about how state based benefits (including any limitations) would apply to your specific circumstances. You may also wish to contact your home state’s 529 plan Program Administrator to learn more about the benefits that might be available to you by investing in the in-state plan.

Investors should consider the investment objectives, risks, charges and expenses associated with municipal fund securities before investing. This information is found in the issuer’s official statement and should be read carefully before investing.

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