If you are planning to save for college expenses for your child or grandchild, a 529 college savings plan can be one of the best ways to do it. You put the money into the plan, it grows tax-free, and then if you use the funds for qualified education expenses, it comes out tax-free as well.
Many students, however, may also apply for financial aid and federal student loans to help cover any remaining costs. Doing this requires completing the FAFSA (Free Application for Federal Student Aid), which many colleges use to determine the student’s eligibility for need-based aid. A 529 plan can potentially negatively impact the student’s eligibility for this need-based aid. The extent of that impact depends on who owns the 529 plan.
Typically, a parent or grandparent owns the plan for the benefit of their child or grandchild, but the students themselves can also own the plan for their benefit. Regardless of the owner, anyone can contribute to the 529 plan (this could raise gift tax issues, which is a topic for another day).
Student or Parent Owned
Whether the dependent student or parent owns the plan, it is considered a parental asset for FAFSA purposes. In general terms, a student’s aid eligibility can be reduced by up to 5.64% of the parental assets that exceed the asset protection allowance (currently approximately $10,000). So, assuming parental assets exceed that allowance, a $30,000 parent-owned 529 plan could reduce the student’s aid eligibility by $1,692. However, distributions from a parent-owned 529 plan have no negative impact on the student’s financial aid eligibility.
Grandparent Owned
Under prior law, when a grandparent owned the plan, the assets in the plan itself were not considered for FAFSA purposes, but any distributions for the student’s benefit would reduce the student’s aid eligibility by up to 50% of the distribution. Under the new version of the FAFSA, which went into effect in December 2023, the assets in the plan itself are still not considered, and now distributions from a grandparent-owned 529 plan will no longer negatively impact the student’s aid eligibility.
Who Should Own It?
The question becomes who should own the 529 plan – parents or grandparents? Like many questions in financial planning, the answer is an anticlimactic “it depends.” The immediately obvious benefit of having the grandparents own the plan is that there is no negative impact on the student’s financial aid eligibility. Further, from the grandparent’s perspective, owning the 529 plan gives them more control over the timing, amount, and recipient of any distributions from the plan – but the same is true for the parents when they own the plan.
Another consideration: many states have a state income tax deduction for contributions into a 529 plan. Unfortunately for clients in Kentucky, that tax benefit is not currently available in the Commonwealth. However, in states where that is the case, the tax benefit may be more valuable to parents in their working years as compared to grandparents in their retirement years.
Potentially the biggest factor in answering the question comes down to behavioral finance. In our observations, parents generally (not a blanket rule) tend to save more into a 529 plan when they own it, and less when they do not – out of sight, out of mind. Many of our clients’ children would not qualify for need-based aid, so that becomes even less of an issue. However, even if the child would otherwise qualify for need-based aid, the benefits of having a plan in place where the parents own it, see it, and control it – and thus tend to contribute more substantially to it during the pre-college years – can outweigh the potential foregone benefits.
Each situation is different and requires its careful consideration and planning. If saving for your child’s or grandchild’s future education is on your radar, let’s have a conversation.
