Does having a 529 account affect financial aid?

529 plans offer a wealth of benefits, including tax-free distributions for qualified educational expenses, investment flexibility, and full parental control of the account.² But many parents are reluctant to open a 529 account because they think it’ll affect their child’s eligibility for financial aid.

529 plans do affect financial aid, but not to the degree you might think. Assets in a 529 are counted as the parents’ assets on the Free Application for Federal Student Aid (FAFSA). When determining your child’s Expected Family Contribution (EFC), which is the formula used to gauge financial aid, the percentage of parents’ assets that’ll be counted to pay for college expenses is capped at 5.64%.³ Depending on your income, a 529 account may have little to no impact on your child’s financial aid package.

Contrast this with a savings account opened in the child’s name. In this scenario, since the account is owned by the child, the amount assessed as part of the EFC is 20%. Many elements influence financial aid, so it’s advisable to complete the FAFSA, regardless of your income and savings.

What’s more, distributions from a 529 account receive favorable treatment on the FAFSA. Qualified distributions from a 529 account that pay for the current year’s college expenses aren't included in the base-year income calculation that could reduce college financial aid eligibility.³

Note that while most colleges follow the FAFSA formula for financial aid, some use their own formulas. As your child determines which schools he or she is interested in, it’s a good idea to contact those schools to see which formula they use.

Strategies for grandparent-owned 529s

529 accounts that are owned by a nonparent family member—such as a grandparent or aunt and uncle—aren’t counted as an asset on the FAFSA; however, withdrawals from the 529 are counted as student untaxed income, with up to 50% of the value affecting financial aid.

One strategy that can help to minimize the impact on financial aid is to change the account owner to the parent. But in some states, this is a taxable transfer. Another is to roll over one year’s worth of funds to the parent’s account. Both account owners’ 529 plans must be in the same state.

A third is to delay using distributions from the nonparent 529 until the child is in the second semester of his or her sophomore year (if graduating in four years) or junior year (if graduating in five). The FAFSA looks at the prior year’s income-tax returns to determine aid eligibility, so waiting may help lessen the impact.

Changes coming soon

The Consolidated Appropriations Act, 2021 will usher in significant changes to the FAFSA, starting with the 2024/2025 school year. One of them will eliminate the need to strategize the use of nonparent-owned 529 accounts, as distributions from a nonparent account will no longer be reported as untaxed income for the beneficiary. Another key change will be to reduce the number of questions on the application and align it more with the parents’ federal income-tax returns.

Before making any big decisions, be sure to sit down with your financial professional, who can help you implement a plan for your child’s future, including setting up a 529 education savings account.

1 “College Savings Statistics,” educationdata.org, July 2021. 2 State laws and treatment may vary. Earnings on nonqualified distributions will be subject to a 10% federal penalty tax. Please speak with your tax professional for more information. 3 FAFSA, 2021.