Financial Aid: 529 Plans and Your Family's Future

Financial Aid: 529 Plans and Your Family's Future

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2015-07-06

 

If you are thinking about joining a 529 plan, or if an account is already in the cards, perhaps understanding more about how 529 funds will affect a child’s chances of receiving financial aid is a good way to go.  Of all the areas related to 529 plans, financial aid is perhaps the one that's most subject to change. But here's where things stand now.

Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing. More information about specific 529 plans is available in each issuer's official statement. Making sure that all the details are known is essential. All of the information about the 529 plan should be read carefully before investing. Also, before investing, consider whether there is a 529 plan that provides residents of a particular state with favorable state tax benefits. For example, if an investor lives in California as opposed to New York State, there may be different rules that apply. As with other investments, there are generally fees and expenses associated with participation in a 529 savings plan. There is also the risk that the investments may lose money or not perform well enough to cover college costs as anticipated.

Financial aid. What is it exactly?

Financial aid is money given to a student to help that student pay for college or graduate school. This money can consist of one or more of the following:

  • A loan (which must be repaid in the future)
  • A grant (which doesn't have to be repaid)
  • A scholarship
  • A work-study job (where the student gets a part-time job either on campus or in the community to earn money for tuition)

The typical financial aid package contains all of these types of aid. Over the past few decades, the percentage of loans in the average aid package has been increasing, while the percentage of grants has been steadily decreasing. This trend puts into perspective what qualifying for more financial aid can mean--a student or child may simply be awarded (and have to pay back) more loans.

The expected family contribution

The financial aid process is all about assessing what a family can afford to pay for college and then trying to fill the gap. The amount that a family is expected to contribute before receiving financial aid is officially called the expected family contribution, or EFC. To calculate a family’s EFC, the institutions that offer financial aid examine the family's income and assets, and then run them through a formula.

The two main sources of financial aid are the federal government and colleges. To determine the applicable EFC, the federal government uses a formula called the federal methodology and colleges use a formula called the institutional methodology.

The difference between the calculated EFC (a constant) and the cost of the child's college (a variable) equals the child's financial need.

The federal methodology and 529 plans

Under the federal methodology, 529 plans (college savings plans and prepaid tuition plans) are classified as an asset of the parent, if the parent is the account owner.

If the parent and the account owner of a college savings plan, the parent must list the value of the 529 account as an asset on the federal financial aid application (called the FAFSA). Under the federal methodology, a parent's assets are assessed (or counted) at a rate of no more than 5.6 percent. This means that every year, the federal government says that 5.6 percent of a parent's assets are available to pay college costs before any financial aid will be forthcoming. (By contrast, student assets are assessed at a rate of 20 percent.)

There are a few special rules to keep in mind about the classification of 529 plans for federal financial aid purposes:

A parent must list a 529 plan account as an asset on the FAFSA only if he or she is the account owner. If a grandparent or other person is the account owner, then the 529 plan does not need to be listed on the FAFSA. However, any student-owned or UTMA/UGMA-owned 529 account is also considered a parental asset and reported as such on the FAFSA if the student files the FAFSA as a dependent student. (A 529 account is considered an UTMA/UGMA-owned account when UTMA/UGMA assets are transferred to a 529 account.)

A corollary to the parent-owned rule is that if a parent is the account owner of several 529 plan accounts for multiple children, then under current rules the parent must list the value of all of the accounts on the FAFSA.

If a parent's adjusted gross income is less than $50,000 and a few other requirements are met, the federal government doesn't count any of that parent's assets in determining EFC. So, a 529 plan wouldn't affect financial aid eligibility at all.

Distributions (withdrawals) from a 529 plan that are used to pay the beneficiary's qualified education expenses aren't classified as either parent or student income on the FAFSA, so they don't affect financial aid eligibility.

The federal methodology and other college savings options

How do other college savings options fare under the federal methodology? Coverdell education savings accounts, mutual funds, and U.S. savings bonds (Series EE and Series I) owned by a parent are considered parental assets and counted at a rate of 5.6 percent. However, UTMA/UGMA custodial accounts and trusts are considered student assets and assessed at a rate of 20 percent.

Also, distributions (withdrawals) from a Coverdell ESA that are used to pay qualified education expenses are treated the same as distributions from a 529 plan--distributions aren't counted as either parent or student income on the FAFSA, so they don't affect financial aid eligibility.

The federal methodology excludes some assets entirely from consideration. These include all retirement accounts (e.g., traditional IRAs, Roth IRAs, employer-sponsored retirement plans), cash value life insurance, home equity, and annuities.

The institutional methodology and 529 plans

Colleges aren't required to use the federal methodology when they distribute financial aid from their own endowment funds. Instead, they typically use a common formula referred to as the institutional methodology. Generally, the institutional methodology digs deeper into a persons  financial situation than the federal methodology to determine what afamily can afford to pay.

The institutional methodology treats 529 plans--both college savings plans and prepaid tuition plans--as a parental asset. When funds are withdrawn from either type of plan, the institutional methodology typically treats the entire amount (contributions plus earnings) as student income.

Note: Like the federal government, colleges count a 529 plan as a parental asset only if the parent is the account owner. If the parent owns several accounts for different children, it's not clear whether all of the accounts would need to be listed, or only the account where the current student is named as the beneficiary.

IMPORTANT DISCLOSURES

Material contained in this article is provided for information purposes only and is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates, Inc. This material does not constitute an offer or recommendation to buy or sell securities and should not be considered in connection with the purchase or sale of securities.

To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.

These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable-- we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

Some of this material has been provided by Broadridge Investor Communications Solutions, Inc.

David Lerner Associates does not provide tax or legal advice. The information presented here is not specific to any individual's personal circumstances.

Member FINRA & SIPC.

 

Tags: college planning, education,529 plan, financial aid, david lerner associates

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516.829.8374 X 232
jmendlinger@zimmed.com

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