529 College Savings Plans: Who Should Be the Owner?

As a refresher, the 529 college savings plan is a tax-deferred account that provides a fantastic means to save for education. Contributions to these plans are invested in a selection of funds and later can be withdrawn tax-free if used for qualified expenses. Also thanks to the recent tax plan, they can also be used for private elementary and secondary school tuition.

We often receive questions about whether a student, parent or other relative should own a 529 college savings plan in regards to the implications of ownership on financial aid. While financial aid does not depend solely on 529 account ownership, income and assets owned will influence financial aid decisions.

When your child is closer to applying to college and you are beginning to crunch the numbers, the first thing to do is check into what financial aid forms a college of choice requires. The Free Application for Federal Student Aid (FAFSA) form is the most commonly used financial aid form, so we will focus on that. While colleges use all kinds of formulas with 529 plans to determine aid, many follow the FAFSA formula. On the FAFSA form, how the college savings plan is reported for dependent students and counted for financial aid will usually depend on the owner of the 529 plan.

On the FAFSA, a 529 plan owned by a dependent student or by a dependent student’s custodial parent, will count as a parental asset and it may reduce need-based aid by a maximum of 5.64% of the asset’s value. A parent’s assets have an impact on financial aid, but 529 plan distributions from a parent-owned 529 have no effect. So if the 529 account is worth $10,000, their child's financial aid award could be reduced by $564.

When an independent student or other relative owns the 529 account, different rules apply.  With these owners, any income, including distributions from a 529 plan, can reduce need-based aid by as much as 50% of the income. Assets owned by a relative, such as a grandparent, aunt, uncle, cousin or non-custodial parent are not included when calculating needs-based aid. Instead, distributions are counted as untaxed income to the beneficiary. With a 50% reduction on income versus a 5.64% reduction on assets, it does make sense for the parent to own the asset and use the lower 5.64% reduction rate. Along the same lines, assets owned by an independent student may reduce aid up to 20%, and because of this, in most cases the independent student who is a beneficiary of a 529 plan and seeking financial aid should not own his or her 529 college savings account.

The only “catch” with this is that a FAFSA looks at the parent owner’s income from two years prior when calculating needs-based aid.  In other words, when filing a FAFSA for 2018, income from the 2016 tax return will be used in the calculation. This presents a great opportunity to time the account ownership to minimize the reductions.

As an example, for freshman and sophomore years, it makes sense for a parent to own the 529 while taking distributions, so that when it comes time to file a FAFSA in junior and senior years, the distributions from the 529 are not counted as income (because they were parent owned). Distributions from 529 plans and regular income are NOT counted towards student aid if owned by the parent. For junior and senior years, ownership of 529 assets can be moved from parents, which are being counted at 5.64%, to grandparents where the assets are not counted. Taking distributions will not matter in these years, because FAFSA is looking back at freshman and sophomore years when calculating income. Since it was owned by the parents for those years, income is not counted at all. This only works if the student is not going to continue with education after senior year in college!

Year

2018

2019

2020

2021

Owner of 529

Parent

Parent

Grandparent

Grandparent

% of 529 assets that reduces financial aid

5.64%

5.64%

0%

0%

FAFSA look-back period

n/a

n/a

2018

2019

 

 

 

 

 

Other things to keep in mind:

  • When changing 529 account ownership from grandparent or other relative owner to parent, some states will seek to recapture state income tax benefits if the account owner is changed. The parent-owned 529 plan should be in the same state as the grandparent-owned 529 plan to bypass recapture rules.
  • A grandparent can rollover a year’s worth of funds to a parent-owned 529 plan. If this is done AFTER the FAFSA is filed, the funds will not show up on the FAFSA. If these funds are spent before the next FAFSA form is filed, they will not show up on that FAFSA either. The timing is important, however. In addition, these distributions will not affect aid because distributions from parent-owned plans do not count in the FAFSA calculation.

This is a lot of information to digest, but more often than not, what we see is that parent-owned 529 plans receive the most favorable treatment. After a review, we often suggest that the custodial parent should own the plan.

 

Presented by Mary Lou Smart, FPQP®                                                                             

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