529 plans have long been the favorite vehicle for college savings with many features that have made them very popular for families and grandparents wanting to help make sure the grandchildren can go to college. Grandparents love 529 plans because they are able to keep control of the assets, they are flexible covering K-12 and post-secondary education, they are easy to manage, have greater growth potential than taxable accounts, avoid gift tax and kiddie tax, can be an estate tax planning tool, a good place to put RMDs, and they can get a state tax break if using their state’s 529 plan. All of these are compelling reasons to use a 529 plan to save for college for the grandchildren. However, you should understand how grandparent 529 plans may have unintended impacts on financial aid qualification.
Who owns the 529 has a direct impact on eligibility for need-based financial aid with dependent student or dependent student parent ownership having minimal impact, but if it is owned by anyone else such as a aunt, uncle, or grandparent, it can inadvertently have negative consequences on the amount of need-based financial aid availability. 529 plans owned by anyone other than the student or custodial parent are not reported as an asset on FAFSA but distributions count as untaxed income to the beneficiary and will reduce eligibility for need-based aid by as much as 50% of the distribution.
So what are some ways to reduce the negative impact of grandparent owned 529 plans on aid eligibility? The easiest is to change the ownership of the 529 plan to a custodial parent but be aware that your state may want to recapture any state tax benefit if you claimed one. Another way would be to take distributions later, i.e. after January 1 of the beneficiaries sophomore year. This works because the FAFSA works off of the prior-prior year’s income and tax information. Another alternative is to roll over of a years worth of tuition to a parent owned 529 after the FAFSA has been filed avoids filing those funds as an asset on the FAFSA. Assets are reported based on the date the FAFSA is filed where income is based on prior-prior year.
Saving for college through a 529 plan is by far the most popular way of providing funding for college and now for K-12, although limited to $10,000 per year, and remains the most beneficial way of saving. However, be aware of how ownership and distribution affects the need-based financial aid process to make sure your best laid plans don’t inadvertently cause financial aid eligibility issues.