529 plans, named after section 529 of an Internal Revenue code, are a popular way for families to save money for college because contributions grow tax deferred and distributions are tax-free when used for qualified higher education expenses. In addition, some states allow some of the contributions to be deducted from the parent’s taxable income. However, the ownership of the plan can dramatically affect a student’s financial aid eligibility.
Case 1 (most common and most desirable): Parent-owned 529 plan.
In this case, the funds in the 529 plan are listed as part of the parent’s investments (question #89 on the FAFSA form). The government (and colleges) will expect families to contribute approximately 5.64% of this and other parent-owned assets towards college each year.
Case 2 (2nd-most desirable): Student-owned 529 plan.
In this case, the funds in the 529 plan are listed as part of the student’s investments (question #41on the FAFSA form). The government will expect families to contribute approximately 20% of this and other student-owned assets towards college each year.
Case 3 (least desirable): Grandparent or other relative-owned 529 plan.
In this case, any distributions of the funds from the plan to pay for college are listed as part of the student’s untaxed income (question #44i on the FAFSA form). The government will expect families to contribute approximately 50% of this and other student income towards college each year!
Therefore, I recommend that parent’s own a 529 plan whenever possible. If a grandparent-owned plan already exists, they can be renamed or rolled-over. Alternatively, distributions can be made after college to pay reduce or eliminate student debt, or made towards the end of the student’s college years, when these distribution will no longer appear on the FAFSA form.
Sources
Free Application For Student Aid (FAFSA) form https://studentaid.gov/sites/default/files/2020-21-fafsa.pdf
FAFSA Calculation worksheet https://ifap.ed.gov/sites/default/files/attachments/2019-10/2021EFCFormulaGuideOct2019UpdateAttach.pdf
Savingforcollege.com https://www.savingforcollege.com/article/workarounds-for-grandparent-owned-529-plans
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