529 Plan Options: When To Undo Them

Grandparents, who started 529 plans thinking it will help their grandkids pay their tuition, may find it can actually penalize them.

529 plan options have been a common savings option for many students, parents and grandparents as the costs of higher education have soared. A 529 plan is a tax-advantage savings plan designed to encourage savings for future college costs.

A 529 account owned by the parent or a dependent student, either directly or via the Uniform Transfers to Minors Act, is reported on the FAFSA application as a parent asset which does impact aid eligibility. It does not get reported as a student asset, which would have a greater impact on aid eligibility. Also, qualified distributions from a 529 account do not get added back to income in the aid formula unlike IRAs. The rules are different for grandparent owned 529’s.

However, sometimes it pays to undo a 529 plan. That may sound surprising to many that have set up 529 accounts but the fact is not all 529 accounts are treated equally. For example, two different students with the same basic profile could get different aid offers based on who actually owns the accounts. A 529 plan owned by a third party, such as a grandparent, is treated differently. The asset value is not reported on the FAFSA, which is favorable, but any use of the account for the benefit of the student must be reported on the following year’s FAFSA and added back as income.

Grandparents, who started 529 plans for their grandkids thinking it will help them pay their tuition, may find it can actually penalize their grandchild for that money if that grandchild qualifies for any financial aid. The issue is that the federal financial aid formula treats assets and income differently. It also treats the student’s money different from that of other relatives. Since any financial-aid income above a certain dollar amount is “assessed” at 50% in the aid formula, the impact of using a grandparent-owned 529 plan to pay for college can be significant.

For example, if a 529 plan of $20,000 is owned by the grandparents and the student withdraws $5,000 from it one year, that withdrawal could increase the amount the family is expected to pay for college and in turn reduce that aid for the next year.

However, if the grandparent anticipates the financial-aid dilemma with a 529 account they have several options.

• The grandparent should consider holding off on any distributions until after the student has filed their final FAFSA going into their senior year of college. This way, the 529 plan money will be used to pay the senior year of college, will have no impact on future federal aid and will qualify for tax-free treatment if the student incurs qualified expenses that match up with the distributions.
• One option may be to simply liquidate the account on a non-qualified basis, pay the associated tax and the 10% penalty for any funds above the amount needed to pay for the senior year
• Another option is for the grandparent to look into transferring ownership of the 529 account to the parent, if the financial-aid consequences work out better. (Be sure to check your 529 plan options before you buy. Some 529 plans do not permit owner changes.)

Deciding what to do with a grandparent owned 529 plan can be a difficult decision and the decision will be different for every family. Make sure that you understand your students’ Expected Family Contribution (EFC), and expected financial aid eligibility, so you know what, if any, impact the grandparent 529 will have on your college funding plan so you’ll be able to make the right choice for your family.

Westface College Planning can help you navigate the college saving and funding process from start to finish. To learn how we can help you call us at 650-587-1559 or sign up for one of our Tackling the Runaway Costs of College Workshops or Webinars.

Photo Credit: s_falkow