By Troy Onink, Forbes Magazine Contributing Writer
Many grandparents save for their grandchild’s college education using 529 college savings plans for good reason, but there is confusion about whether or not it will hurt the grandchild’s eligibility for college financial aid. The answer is that it depends, but even if it does it may not have a big impact.
529 college savings plans are a type of account that can be used to save for college and have any earnings on the investment in the plan come out tax-free to pay for qualified college expenses. The federal financial aid rules say that if a 529 plan is owned by the student or the student’s parent(s), any distributions from the plan will not be counted as income for calculating need-based college aid eligibility. That is good.
The rule doesn’t apply to grandparent-owned 529 plans, however, so any distributions from the grandparent-owned 529 do get counted as untaxed income to the grandchild on the financial aid forms filed the following year. The following year the full amount of the distribution, say $10,000 as an example, is counted as untaxed income to the grandchild (college student).
In the aid formula, however, the grandchild gets an income protection allowance of $6,310 (for 2015). Assuming the grandchild has no other income, the $10,000 will be reduced the IPA of $6,310 and the student’s net available income will be $3,690, and be counted at 50%, generating a student contribution from the $10,000 distribution of $1,845. So the net result, if in fact the student was otherwise eligible for need-based aid, is that the $10,000 distribution from the grandparents only impacted aid eligibility by $1,845 the following year.
If the student was already not eligible for need-based college aid due to family finances and choice of college, then the impact on aid eligibility is $0.
529 plan accounts owned by the student or parent will be counted as an asset and assessed at a rate of up to 5.64% (parent) and 5.64% (student) only on the FAFSA aid form. On the CSS Profile, the asset is assessed at 5% (parent) and 25% (student), but grandparent-owned 529 accounts do not get assessed as an asset.
Furthermore, you save in 529 plans to PAY FOR COLLEGE. To get the tax-free distribution you have to use the funds to pay for qualified college expenses. So get the tax-free growth and use it for what it is intended.
Troy Onink is the CEO of Stratagee, a college planning consulting firm that helps parents determine their best strategy to pay for college.