Driven by the skyrocketing cost of a college education, it is no surprise that 529 plans have continued to grow in popularity. The College Savings Plan Network estimates that total investments in 529 plans had reached $371.5 billion in 2019. With over 14 million accounts, the average account size also ballooned up to $26,054 in 2019.
There are many reasons for the popularity of these plans. They are investment accounts specifically allocated for future education costs, users may qualify for a tax deduction or credit for contributing, and earnings on the 529 increase on a tax-advantaged basis.
Plan Ownership and FAFSA
Ownership of a 529 plan has a direct effect on FAFSA (Free Application for Student Aid) eligibility. Under the rules, if a grandparent or other non-parent relative owns a 529 account, its existence does not have to be reported on the initial FAFSA. That means that money in those plans will not affect a student’s financial aid eligibility in the beginning.
When the parent of a student owns the 529 plan, however, that plan is considered an asset that must be reported on the FAFSA. Although the parent plan will be a reportable asset, less than 6% of parents’ assets are considered available to pay for college.
Knowing these factors, families should consider carefully who should own the 529. There are planning opportunities around both the ownership and timing of distribution from plan accounts. While any 529 distribution used directly for college is tax-free, the ownership will determine how it affects FAFSA eligibility. For example, when a grandparent or other relative takes a distribution for the student from their own account, this is considered untaxed student income which can greatly affect future student aid eligibility.
One planning option is to shift ownership from a grandparent 529 plan to a parent-owned plan to pay for the first two years of college. This could have less of an overall impact than a grandparent-owned plan distribution. The timing of such an ownership shift would need to be considered.
Planning is different if a grandparent takes a distribution from their own plan for the student. In this case, they might consider waiting until after January of a student’s second year of college to avoid reporting income for the 529 plans they own. This is because FAFSA looks at income and tax information from the “prior-prior year” which effectively allows a look back of two calendar years.
Naming a contingent owner to a 529 plan is also very important. In most states, the custodian of the 529 plan must name a contingent owner, who would step in and manage the 529 plan in the case of the custodian becoming unable. Considering the FAFSA issues above, a grandparent should at least consider making the child’s parent as the successor owner.
If a 529 ownership change from grandparents to parents is optimal, the IRS allows one tax-fee rollover per year for plans with the same student. In this case, there are no gift or income tax consequences.
If you have questions about 529 plans, or any other questions about saving or paying for college, feel free to reach out to us.
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