By Artie Green
If you have a child, chances are someone in your family has set up a 529 college savings plan for him or her. Most of the thinking involved in setting up a 529 plan revolves around which state’s plan to use.
Less thought is generally given to who should own the plan, and the consequences of that decision could have a pretty big impact on the amount of financial aid your child may be able to receive.
First, it helps to understand how the standardized Free Application for Federal Student Aid (FAFSA) financial aid model works. When you apply, you provide information about your and your child’s income and assets. The government uses that information to calculate your Expected Family Contribution (EFC), the amount your family should be able to contribute to your child’s college education without going broke (or worse). The higher the income and assets, the more your family will be expected to contribute toward your child’s college expenses and the less student aid you’ll be offered.
Because the weighting of these factors varies, you can reduce your EFC by strategically locating assets in accounts that count less toward the EFC. Specifically, only 22-47 percent of the parents’ income (depending on income level) and between 2.5 and 5.6 percent of the parents’ assets (excluding home and retirement accounts) are counted. By contrast, 50 percent of the child’s income and 20 percent of his or her assets count toward the EFC. Clearly, one good way to reduce your EFC is to spend down your child’s assets prior to or early during his or her college career.
Where does the 529 plan fit in? It’s counted as an asset of the owner. If the plan was set up using the parents’ money, it is most likely owned by one of the parents, and therefore no more than 5.6 percent of the balance in the plan would count toward the EFC. But if the plan was created using money from a child’s Uniform Gifts to Minors or Uniform Transfer to Minors account, then the child would be considered the owner, and the balance would have a much bigger impact on the EFC.
In an effort to keep the 529 plan from being counted at all, numerous families follow the strategy of having the grandparents own the plan. Assets owned by grandparents do not count as a family asset toward the EFC, even if the parents were the ones to contribute to the plan. However, this approach can actually result in a higher EFC. Why? Because distributions from a grandparent-owned 529 plan count as income to the student.
For example, suppose that you set up a $100,000 529 plan for your son that is owned by your mother (his grandmother). If the plan pays for $25,000 of college expenses annually, that’s $12,500 of income (50 percent of $25,000) that will be counted toward the EFC each year. By contrast, if you chose to own the plan yourself, a maximum of only 5.6 percent of the balance ($5,600) would be counted, and that amount would decline each year as the balance is depleted.
I’ve evaluated several strategies designed to minimize the 529 impact on your EFC. In the end, I’ve found that the most effective is to create two separate 529 plans, one owned by the grandparent and one by the parent, with 75 percent of the available funding going into the parent’s plan. The parent’s plan should be used for all expenses through junior year, and the grandparent’s plan should be used for senior-year expenses. This approach minimizes the size of the parent’s asset throughout the college years, plus takes distributions from the grandparent’s plan at a time when they will no longer have any effect on the EFC (unless the child decides to continue in college for a fifth year). It also avoids any potential problems with transferring ownership of 529 plans, another common strategy that not all states allow.
Of course, if your income is such that your EFC is higher than the cost of college, then none of this will matter to you. But with college costs continuing to grow at more than twice the rate of inflation, it may not be long before you find yourself spending several weekends intimately getting to know the FAFSA.