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Will a 529 Plan Affect Financial Aid Eligibility or Amount?

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A 529 plan can influence financial aid eligibility and the amount awarded. While these savings plans are valuable for covering education expenses, they are considered parental assets on the Free Application for Federal Student Aid (FAFSA). As such, they can reduce the amount of need-based financial aid a student may receive. However, while a 529 plan may slightly decrease financial aid eligibility, it still remains a beneficial tool for college savings. If you need help with your financial planning, consider talking to a financial advisor.

How a 529 Plan Works

A 529 plan is a tax-advantaged savings account designed to help families set aside money for future education costs. Named after Section 529 of the Internal Revenue Code, these plans are sponsored by states, state agencies or educational institutions. They are primarily used to cover qualified education expenses, such as tuition, fees, books and sometimes room and board, for college or other post-secondary education.

One of the key benefits of a 529 plan is the tax advantages it offers. Contributions grow tax-free, and withdrawals are also tax-free when used for qualified education expenses. Many states also offer tax deductions or credits for contributions to a 529 plan. This can result in significant savings over the long term, making it an attractive option for families planning for future educational needs.

Contributing to a 529 plan is straightforward. Individuals can set up an account with a 529 plan provider and then contribute funds as they see fit. There are no annual contribution limits, but contributions cannot exceed the amount necessary to provide for the beneficiary’s qualified education expenses. Many plans allow for automatic contributions, making it easier to save regularly. Additionally, contributions can come from parents, grandparents or other family members and there is flexibility in changing the beneficiary if needed.

How Financial Aid Is Calculated

A child putting away money symbolically for college.

The calculation of need-based financial aid begins with the Free Application for Federal Student Aid (FAFSA). This comprehensive form collects detailed information about a student’s and their family’s financial situation. The primary goal is to assess the family’s ability to contribute to college expenses, known as the Expected Family Contribution (EFC). The EFC is determined by considering several factors, including income, assets, family size and the number of family members attending college.

Income is a primary determining factor in the financial aid calculation. Both the student’s and parents’ incomes are considered, with higher earnings generally leading to a higher EFC and potentially less financial aid. Assets, such as savings accounts, investments and real estate (excluding the family home), are also evaluated. However, parental assets are assessed at a lower rate than student assets, reflecting the broader financial responsibilities of parents.

Family size and the number of siblings attending college simultaneously also play significant roles in determining financial aid. Larger families with multiple children in college at the same time often have a reduced EFC, recognizing the increased financial burden. This adjustment can result in a higher amount of need-based aid for each student.

The cost of attendance (COA) at the chosen institution is another important factor. COA includes tuition, fees, room and board, books, supplies, and other educational expenses. Each school’s COA varies, and financial aid offices use it in conjunction with the EFC to calculate financial need. The formula is simple: COA minus EFC equals financial need.

How 529 Plans Can Impact Financial Aid Calculations

A 529 plan does have implications for financial aid calculations. Primarily, these savings plans are considered parental assets when completing the Free Application for Federal Student Aid (FAFSA). This classification impacts the expected family contribution (EFC), which is a key determinant in assessing financial need and aid eligibility.

When a 529 plan is classified as a parental asset, up to 5.64% of its value is included in the financial aid calculation. This is notably less than the rate at which student-owned assets are assessed, which can be up to 20%. Therefore, although the presence of a 529 plan can reduce the amount of need-based financial aid a student might receive, the impact is relatively modest when compared with other types of savings or investments.

Withdrawals from a 529 plan used for qualified education expenses do not count as income on the FAFSA, thereby not affecting the financial aid calculation in the subsequent year. However, if grandparents or others own the 529 plan, distributions can be counted as untaxed student income, potentially reducing aid eligibility. This can be mitigated by timing the withdrawals strategically, such as after the student has filed their final FAFSA.

Considering the rules governing 529 plans and financial aid calculations, families are encouraged to plan carefully. Contributions should be balanced to avoid excessive reductions in need-based aid. Additionally, families might consider leveraging other savings vehicles that are assessed differently or not at all in the financial aid formula. Consulting with a financial advisor can help navigate these complexities and develop a comprehensive strategy tailored to the family’s financial situation and educational goals.

Bottom Line

A parent helping his daughter do homework.

While a 529 plan can slightly impact financial aid eligibility, its benefits often outweigh the drawbacks. These plans are counted as parental assets on the FAFSA, which can reduce need-based aid by a modest amount. This might be a deal breaker when factoring your college costs. However, the tax advantages and flexibility of 529 plans make them a valuable tool for college savings. Families can strategically manage their contributions and withdrawals to mitigate any potential negative effects on financial aid.

Tips for Education Planning

  • A financial advisor has the expertise necessary to help you with all of your financial planning needs, from college to retirement. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Trying to figure out how much you’ll need to save for your child’s college? Consider this guide on how much you should save for college.

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