Many parents fear that saving for college in a 529 plan will prevent their children from getting financial aid. It’s a common concern, but fortunately, your college savings have a minimal impact on future financial aid awards. When the time comes to start paying for college, you’ll be glad you saved diligently for your child’s future.
How 529 Plans Work
When you open a 529 plan, you set aside money specifically for your child’s education; this particular type of account has some clear tax advantages over other savings. (Your earnings grow tax-free and aren’t taxed when you withdraw money for qualified educational expenses.) Once your child is ready to go to school, the money you contributed plus the interest that has grown can be used to pay for college expenses.
How FAFSA Works
The Free Application for Federal Student Aid (FAFSA) is the application that families use to apply for federal college aid, including grants, loans, and work-study funding. FAFSA is managed by the U.S. Department of Education and provides over $112 billion to college students annually.
You should complete the FAFSA even if you’re unsure if you qualify for a federal grant or loan. Most schools use this standardized form to determine scholarships as well as grants and loans.
529 Plans and Financial Aid
You’ve established a 529 plan, contributed to it diligently, and now your child is ready to attend their favorite school. This fund will help you pay for college expenses, but it will have a minimal impact on your overall financial aid award. Both the owner of the fund and your family’s income matter when considering your 529 plan and how it affects your costs in the long run.
Who Owns the 529 Plan?
Your assets matter in the equation when determining your financial aid, and a 529 savings plan is considered an asset. Ownership of these assets matters and will greatly influence how much you will ultimately contribute. Parent assets are assessed differently from student assets, so if you, the parent, own the account, it is more beneficial for getting better results.
When a parent owns the 529 accounts, only 5.64% of the saved amount is counted when calculating your EFC, leading to a larger financial aid package for the student. The age of the older parent also plays a role; the age of the older parent can affect how much your 529 savings count against your child’s college costs. This financial protection allows for some income for older parents and is greater for married parents aged 65 and older.
How 529 College Savings Affect Your EFC
How much do 529 college savings affect your child’s financial aid awards? It depends on how much you save, your other assets, and your family size even. A look at two hypothetical families illustrates how typical 529 savings accounts will impact the total college cost.
The Smith and Jones families live in California and have children heading to the same school this year; tuition costs are $50,000 annually. The Smith family saved $75,000 in a 529 plan; while the Jones family didn’t start a savings account at all. Both families have the same income and family size.
For the Smith family, having those extra savings means their family contribution increases slightly; that extra savings of $75,000 means the total EFC for the first year of school is $15,936, using a quick EFC calculator and an adjusted gross income of $70,000. They withdraw the necessary amount from their 529 account to cover the school year’s costs.
For the Jones family,
For the Jones family with no savings, the EFC for the first year will be the same at $11,706, using the calculator and the same income and family numbers.
Save or Not to Save?
The Smith family finds that their 529 plan affects their financial aid award by about $4,200 per year; they use the saved money to pay their EFC each year. After four years of schooling, their child graduates with little or no student debt at all due to the availability of funds to cover tuition costs.
The Jones family did not save money but received about $4,200 more in financial aid compared to their saving peers. They need to cover their EFC and do so through student loans. When their child graduates, they do so with about $50,000 in student loans that they need to start repaying within a year of graduation.
The takeaway for saving for college is that the money you set aside in a 529 plan will have a minor impact on your financial aid award each year, but having that money available will significantly reduce the total amount of student loans you need to apply for each year.
These calculations only apply to money invested in a 529 plan. Withdrawing money from your retirement savings or regular savings account will not provide you the same tax advantages and will not offer the same benefits when you’re ready to pay college costs.
Frequently Asked Questions (FAQs)
Does a grandparent’s 529 plan affect financial aid? A grandparent’s 529 plan does not need to be reported as an asset on the FAFSA. However, any distributions from that plan must be reported as untaxed income on future FAFSAs. In other words, they are considered income and could have a significant impact on financial aid eligibility.
However, a new FAFSA model will be implemented starting the 2024-2025 academic year, which will not require students to disclose this income. This means that grandparent 529 plans will no longer affect need-based financial aid eligibility for students.
What are the disadvantages of 529 plans? One disadvantage of 529 plans is that they do affect the amount of aid you’re eligible for, although this effect is minor compared to the long-term benefits. Another thing to be aware of is that there are penalties for spending the money on non-educational expenses or for withdrawing the funds at the wrong time or in the wrong amount.
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Sources:
– U.S. Securities and Exchange Commission. “An Introduction to 529 Plans.”
– Federal Student Aid. “About Us.”
– U.S. Department of Education. “What Is Expected Family Contribution?”
– Congressional Research Service. “The FAFSA Simplification Act.”
– USC Center for Higher Education Policy Analysis. “IDAs and Financial Aid: Understanding the Puzzle and Sharing Best Practices,” Page 27.
– Federal Register. “Vol. 86, No. 135/Monday, July 19, 2021/Notices.”
– Columbia Threadneedle Investments. “Why Grandparents Have Greater Incentive To Own 529 Accounts.”
Source: https://www.thebalancemoney.com/will-529-plan-hurt-your-financial-aid-chances-4151976
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