The cost of a college education in the United States continues to rise, and the student loan debt burden has a lot of prospective students worried about their financial futures.
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.
What Is a 529 Plan?
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:
- College Savings Plan. You can use these investment plans to pay for education at a private or public institution in any state.
- Prepaid Tuition Plan. You make fixed payments now to lock in today’s tuition rates for in-state public schools. (Private College 529 Plans are also available to prepay for private schools, but these are separate from state-sponsored plans.)
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.
Benefits of a 529 Plan
A 529 college savings plan can be a smart way to save and invest money for college because:
- The account incentivizes college savings to reduce the temptation to spend money on something else.
- Any money you can pay out of pocket for education is less debt you have to take on.
- You can deduct contributions on most state taxes and investment earnings on federal and most state taxes.
- Anyone can start a 529 plan to benefit any future student, so your relationship doesn’t restrict your ability to help.
- It’s an investment account, so your contributions grow over time, and you’ll likely have access to more money than you contributed by the time you withdraw.
- It encourages you to start saving early, which spreads the financial burden over several years.
- You can keep the money in a parent’s name, rather than the student’s, which could be an advantage when applying for financial aid.
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.
Reporting 529 Plans on FAFSA
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.
- Parental Asset. You report the value of the 529 account as a parental asset on the FAFSA if the student is required to report parental information and the account is in the parents’ or student’s name.
- Student Asset. You report the value of the 529 account as a student (or spouse) asset if the student isn’t required to report parental information, and the account is in the student’s (or spouse’s) name.
- Cash Support. You report distributions from a 529 account (not the full value) as “money paid on your behalf” if the account is in anyone’s name but the student’s or parents’, including grandparents and non-custodial parents.
How Does a 529 Plan Affect Financial Aid?
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.
How Does a 529 Plan Affect Scholarships?
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.
Don’t Let a 529 Plan Hurt Your Financial Aid Eligibility
Plan ahead, if you can, to keep a 529 plan from hurting a student’s financial aid eligibility in the future.
Before You Open a 529 Account
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 Someone Has Already Opened a 529 Account
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 roll over the plan into a new 529 account (similar to a retirement plan rollover), then transfer ownership.
If You Can’t 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.
Final Word
A 529 college savings 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 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.
