Best Place to Hold Your 529 Plan
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 utilize. Less thought is generally given as 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.
It first 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), which is quite simply 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 the higher the 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 towards the EFC. Specifically, only 22% to 47% of the parents’ income (depending on your income level) and between 2.5% and 5.6% of the parents’ assets (excluding your home and your retirement accounts) are counted. By contrast, 50% of the child’s income and 20% of his or her assets count towards the EFC. Clearly one good way to reduce your EFC is to spend down your child’s assets prior to or early during their 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% of the balance in the plan will count towards the EFC. But if the plan was created using money from a child’s UTMA or UGMA 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 towards 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. Let’s take an example. Suppose you’ve set up a $100K 529 plan for your son that is owned by your mother (his grandmother). If the plan pays for $25K of college expenses annually, that’s $12,500 of income (50% of $25K) that will be counted towards the EFC each year. By contrast, if you chose to own the plan yourself, a maximum of only 5.6% 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% of the available funding going into the parent’s plan. The parent’s plan should be utilized for all expenses through junior year, and the grandparent’s plan should be utilized 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 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 which 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 too find yourself spending several weekends intimately getting to know the FAFSA!