How to Maximize College Financial Aid With 529s
Last year I wrote about a strategy involving 529 plans designed to maximize the financial aid a college student could receive (see https://www.cognizantwealth.com/2014/03/10/best-place-to-hold-your-529-plan/). To summarize the original strategy: if you split your savings into two 529 plans, 75% in one owned by the student’s parent and 25% in one owned by the student’s grandparent, you will minimize the impact the funds in those plans will have on your expected family contribution each year and consequently maximize the financial aid your student may potentially be offered throughout his/her college career.
A couple of months ago President Obama signed an executive order changing the rules. As a result, the above strategy needs to be updated.
Why the changes? Primarily to make the process of filling in the Free Application for Federal Student Aid (FAFSA) easier and quicker. Beginning with the 2017-2018 school year, the reported income for the student and his/her parents will be based on data from the prior-prior year (2015) rather than from the prior year (2016). This resolves the problem applicants faced every January trying to figure out their previous year’s income when they hadn’t even completed their previous year’s taxes yet. Even better, applicants will now be able to utilize the IRS’ automated Data Retrieval Tool to populate the FAFSA, making the process faster and less error-prone. Finally, the initial application process is shifted back to October of the preceding year (a full 11 months before the student will matriculate), giving your child more time to consider costs as he/she evaluates schools to which to apply.
So what impact does this rule change have? Basically, it removes the third year of college expenses from the FAFSA calculation. In other words, it makes no difference how you pay for the student’s junior year since income and assets in that year will have no effect on his/her senior year. Therefore the new financial aid maximization strategy should be to split your savings equally (50% each) between the parent’s 529 plan and the grandparent’s 529 plan. As with the original strategy, the parent’s 529 plan should be utilized for the first two years of college, and the grandparent’s plan for the latter two. If your child takes five years (or more) to complete school, it’s always the last two that should be funded by the grandparent’s 529 plan.
One interesting side effect of this change is that your 2015 earnings will be used for the 2016-17 school year as well as for the 2017-18 school year. If you have the ability to reduce your (and/or your child’s) income during that one year it will count twice towards maximizing his/her aid prospects!
As I have written before, there are other tax-efficient strategies you can implement for college savings. And always remember that it’s good to have a contingency plan just in case your child chooses not to go to college.