Though the school year is winding down, there’s still time to complete the Free Application for Federal Student Aid (FAFSA). For the 2020–21 school year, the deadline for filing FAFSA is June 30, 2021 (and you have until September 11, 2021 for any corrections or updates).
While completing the FAFSA form for your student enables them to be considered to receive federal financial aid, it’s not the only thing you can do to help ease the burden of college expenses. Another option is setting up a 529 savings plan.
What Is a 529 Plan?
A 529 plan is an education savings plan operated by a state or educational institution. They act like savings accounts that allow parents or grandparents to make after-tax contributions and have them grow tax-free. The money can then be used to pay for qualified education expenses like tuition, fees and books.
While the earnings from these plans are not subject to federal taxes, in most cases, 529 plans are exempt from state taxes as well. Another advantage is that the donor, not the beneficiary, maintains control of the account.
For those saving for a child or grandchild when they’re young, the beneficiary of the account can be changed, should the original beneficiary decide they don’t want to go to college. You may update who the beneficiary is as many times as you like, even from generation to generation. To make the transfer without penalty, the new beneficiary must be a member of the prior beneficiary’s family. This means that if there are excess funds leftover when the original beneficiary graduates, that money can be used on the education of another beneficiary.
Funds in a 529 plan may be able to be returned to you, but you would be subject to income tax on the withdrawal, as well as a 10% penalty tax. Because of this, you should avoid withdrawing money from a 529 plan unless absolutely necessary.
Prior to investing in a 529 plan, investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other benefits that are only available for investments in the state’s qualified tuition program. Please consult with your tax advisor before investing.
529 Plan Effects on FAFSA
When students are filling out their FAFSA, the application treats income and assets differently, with income assessed at a higher rate than assets. In terms of weight, FAFSA views students’ income and assets at a higher rate than parents’ income and assets.
If a 529 plan’s donors are the parents of the student beneficiary, the government views that account as a parental asset. A student’s personal 529 plan can also be viewed as a parental asset, as long as the student is still a dependent. If the student is independent, the plan will be assessed at the higher, student asset rate.
If you’re a grandparent and have an existing 529 plan, or you would like to establish a 529 plan for your grandkids, FAFSA just recently changed how they view those contributions. It used to be that grandparents’ 529 plans were classified as students’ income. Income is eligible to be assessed at a much higher level than assets—as much as 50% of the withdrawal may be assessed by FAFSA. Therefore, contributions from grandparents’ 529 plans could decrease the amount of federal financial aid a student can receive in future years and increase their financial burden.
However, due to recent changes, those hurdles for grandparents have been removed. Starting October 1, 2022 (and affecting the 2023-24 school year), two-thirds of existing questions will be removed from the FAFSA, including one that asks about cash gifts from grandparents. As such, grandparents’ contributions from 529 plans won’t negatively affect any potential federal financial aid for the student. And since the student’s FAFSA includes income and tax information from the prior-prior year, the 2023-24 FAFSA will include information from 2021 tax returns. This “prior-prior” rule for income reporting means that grandparents can actually start taking advantage of the new rules this year.
The Bottom Line
While 529 plans may seem straightforward, the ownership of an account may have a large effect on a beneficiary’s financial aid status. If you have more questions about your 529 plan and how it can affect your student’s FAFSA, contact a financial advisor to discuss the options available to you.
This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
Prior to investing in a 529 plan, investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other benefits that are only available for investments in such state’s qualified tuition program.
CFP® Tiffany has lived around the globe and brings her worldly life experiences to her everyday work. Starting in the industry in 2007, she learned the importance of understanding not only the big picture and details in order to fully implement plans, but also her clients’ values and relationship with money. She has a passion for music and has performed in places from China to Germany to home in Atlanta. Tiffany lives in Smyrna with her husband, Rich, and their English Bulldogs, Goombah and...Read More