It’s no secret that a 529 plan offers tax advantaged growth for college expenses like tuition, books, supplies, etc. What isn’t as clear is who should own the account? The parent or the grandparent?
As CERTIFIED FINANCIAL PLANNERS™, we get this question a lot, especially in the fall. It’s on the mind of many as October 1 marks the opening window for students to apply for their FAFSA (Free Application for Federal Student Aid) for the 2019-2020 school year. Like many financial planning topics, there’s no one right answer.
If your hope is to maximize your financial aid offer, the 529 plan is best owned by a parent.
Some of you may have read that and thought, “Wait a minute, I heard that assets owned by grandparents aren’t considered on the FAFSA!” That is true, but consider this: up to 5.64% of the assets owned by parents are considered for financial-aid purposes. In comparison, grandparent-owned 529 plans don’t count at all – until a distribution is made. At that time, up to 50% of the money distributed from a grandparent-owned 529 plan is considered for financial-aid purposes.
Example: $10,000 in a parent-owned 529 plan could increase the Expected Family Contribution to college expenses by $564. $10,000 distributed from a grandparent-owned 529 plan would increase the Expected Family Contribution to college expenses for the following year by as much as $5,000.
The Expected Family Contribution may impact the types and amount of financial aid offered and it’s exact impact on your situation will vary based on your family’s financial picture.
Example: For students who are eligible for the Federal Pell Grant (low-income students and families), an increase of $564 in the Expected Family Contribution might reduce their grant by that much. An increase of $5,000 would push them to the top end of grant eligibility. If a student only qualifies for loans in their financial aid package, an increase in their Expected Family Contribution (whether it’s $564 or $5,000), isn’t likely to impact their aid package.
Does your student currently have a grandparent-owned 529 plan?
One way to maximize the tax-advantaged account and minimize its impact on the FAFSA is to coordinate an annual transfer from the grandparent-owned 529 plan to the parent-owned 529 plan, after you file for the FASFA for your student’s freshman year. The first year aid package would not include the 529 asset at all. In the years to come, the FAFSA would simply show that the money was used to pay for college expenses. Therefore, it won’t be reported as income on the form.
Example: 1) Apply for the FAFSA October 2018. 2) Once your student receives their aid package, transfer the amount of one-year of qualified expenses (around $25k for in-state public school) from a grandparent-owned 529 to a parent-owned 529. Pay expenses from this account throughout the year, ideally ending the school year with very little left in the parent-owned 529 plan. 3) Next fall, repeat the process.
Whether or not this strategy benefits your family will depend on the assets, income and size of your household. If you want to get a better handle on the specifics of your Expected Family Contribution (EFC), click here to review the formula guide, or visit with your college’s financial aid department. In addition to the EFC details, you’ll want to assure that your state’s 529 plan allows periodic transfers and assure both plans are in the same state to avoid state income-tax issues.
(Note: If you are an owner of an Oregon College Savings Plan 529 account, there are some administrative changes afoot that will impact your plan in the very near future. Click here for more detail.)
Another option for grandparent-owned 529 plans is to wait until the student has two years of school left to distribute from the 529 plan.
Since the FASFA has a 2 year look-back to review income and assets in considering the aid package they will offer, distributions from the grandparent-owned 529 will not be included in their junior or senior aid packages.
This plan too requires attention. Don’t let your effort to maximize the financial aid package hinder you from utilizing the 529 funds for their intended purpose. Even the most carefully crafted financial aid package won’t feel so great if your student still has funds in their 529 at graduation!
Proceed with Caution
Obviously, these strategies take planning that you may not have the time to tackle. In these cases, it may be easiest just to roll the plan from the grandparent to the parent (if your plan allows it; some don’t), perhaps after the first year of college.
If you’re wondering what strategy is best for you and your student, give us a call. We’re here to help.
Bonus tip: You may have heard that the recent tax reform changes now allow 529 plans to be used for K-12 private-school tuition. It’s true that $10,000/year can be withdrawn from a 529 plan to pay for these expenses without incurring federal taxation or penalty; however, in many states (including Oregon), they are subject to state tax. This certainly has an impact on the tax-advantaged growth so we encourage you to take care and get professional advice when making withdrawals for these types of expenses.