How Do Grandparent-Owned 529 College Savings Plans Affect Financial Aid Eligibility?

How Do Grandparent-Owned 529 College Savings Plans Affect Financial Aid Eligibility?

Only 529 college savings plans that are owned by the student or the

student’s parents are reported as assets on the Free

Application for Federal Student Aid (FAFSA). So a 529 plan owned by a

grandparent or other third party will not be reported as an asset on

the FAFSA. However, qualified distributions from such a 529 plan are

treated as untaxed income to the beneficiary on the

subsequent year’s FAFSA, potentially having a big impact on

eligibility for need-based financial aid. (Non-qualified distributions

are included in the adjusted gross income of the beneficiary

regardless of who owns the 529 plan.)

This can have a big impact on eligibility for need-based financial

aid. Student assets will reduce aid eligibility by 20% of the asset

value (minus a small asset protection allowance) and parent assets

will reduce aid eligibility by as much as 5.64% of the asset

value. However, student income, including untaxed income, will reduce

aid eligibility by 50% of the distribution amount (minus a small

income protection allowance). Usually the treatment of 529 plan

distributions as income will have a much more severe impact on aid

eligibility than the treatment of 529 plans as assets.

Inaccurate Information Common

Many web sites, including those of a few 529 plan administrators,

contain inaccurate information about the impact of a grandparent-owned

529 plan on eligibility for need-based financial aid. These web sites

often incorrectly state that grandparent-owned 529 plans have no

effect on financial aid eligibility. The misinformation is

surprisingly persistent.

Here are a few examples of such errors:

There’s also an interesting strategy if you have relatives who want to

contribute to your child’s education: A grandparent or someone else

can open a 529 plan in their name, with the child as beneficiary,

instead of depositing money in your plan. Since the contributor “owns”

the account, it has zero impact on FAFSA financial aid calculations.

… accounts that are owned by a grandparent have no impact when

determining eligibility for financial aid on the FAFSA, and the value

of a 529 plan is generally excluded from the grandparent’s estate.

Another attractive feature of 529 plans is that under current law,

grandparent-owned 529 accounts are excluded by the federal

government’s financial aid formula — only parent-owned 529 plans

count. So a grandparent-owned 529 plan won’t impact a grandchild’s

chances of qualifying for federal aid.

Q: I’m considering a 529 plan for my grandchild but will I hurt my

grandchild’s chances of receiving financial aid?

A: 529 accounts owned by grandparents (or other non-parent) are not reportable as an asset on the FAFSA financial aid application. … Grandparent owned 529 accounts are not counted in determining financial aid eligibility; all the more reasons for grandparents to make gifts to their grandchild’s 529 plan.

To help debunk this misinformation, this article documents the

treatment of 529 plans as encoded in the statute and subregulatory

guidance.

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Correct Treatment of 529 Plans as Income and Assets

The College Cost Reduction and Access Act of 2007 (CCRAA)

(P.L. 110-84) amended subsection 480(a)(2) of the Higher Education Act

of 1965 to change the treatment of 529 plans on the FAFSA, effective

July 1, 2009. The statutory language as amended by the CCRAA reads as

follows:

and no distribution from any qualified education benefit described in

subsection (f)(3) that is not subject to Federal income tax, shall be

included as income or assets in the computation of expected family

contribution for any program funded in whole or in part under this

chapter

This section of the Higher Education Act of 1965 is often

misinterpreted as indicating that all distributions from 529 plans are

ignored on the FAFSA. However, the language “described in subsection

(f)(3)” is important because it limits the scope of the 529 plans for

which distributions are excluded from income to just those plans

described in subsection 480(f)(3) of the Higher Education Act of

1965. Distributions from plans that are not described in subsection

480(f)(3) may still be counted as income on the FAFSA.

Subsection 480(f)(3) of the Higher Education Act of 1965 reads as follows:

A qualified education benefit shall be considered an asset of —

(A) the student if the student is an independent student; or

(B) the parent if the student is a dependent student, regardless of whether the owner of the account is the student or the parent.

Subsection 480(f)(3) describes the 529 plans that are reported as

assets on the FAFSA as including only plans that are owned by the

student or parent. Grandparent-owned 529 plans (and all other 529

plans owned by someone other than the student or parent) are not

reported as assets on the FAFSA because they do not fall within the

scope of subsection 480(f)(3).

But it is also precisely because such 529 plans do not fall within the

scope of subsection 480(f)(3) that distributions from such 529 plans

count as untaxed income on the subsequent year’s FAFSA. The reference

to subsection 480(f)(3) in subsection 480(a)(2) restricts the

exclusion of 529 plan distributions from income on the FAFSA to just

the 529 plans described by subsection 480(f)(3), namely the 529 plans

that are reported as an asset on the FAFSA.

Thus, if a 529 plan is not reported as an asset on the FAFSA,

distributions from the 529 plan count as untaxed income to the

beneficiary on the subsequent year’s FAFSA. The treatment of a 529

plan as an asset cannot be separated from treatment of distributions

as income. The two are inextricably linked.

For example, distributions from a grandparent-owned 529 plan are counted as

untaxed income to the beneficiary on the subsequent year’s FAFSA

because the grandparent-owned 529 plan is not reported as an asset on

the FAFSA.

A similar treatment also applies to other qualified education

benefits, such as prepaid tuition plans and Coverdell education

savings accounts.

Note that if a student’s parents are divorced, the income and assets

of the non-custodial parent are not reported on the student’s

FAFSA. In particular, if the student’s 529 plan is owned by the

non-custodial parent, the 529 plan is not reported as an asset on the

FAFSA, but any distributions from the 529 plan count as untaxed income

to the student on the subsequent year’s FAFSA.

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US Department of Education Guidance

The US Department of Education has published guidance that is

consistent with this interpretation of the statute in the 2009-10 and

2010-11 Application and Verification Guides. According to the US

Department of Education, distributions from a 529 plan owned by

someone other than the student or parent are reported as untaxed

income on the subsequent year’s FAFSA. The following is an excerpt

from page AVG-18 of the 2010-11 Application and Verification Guide

(emphasis added):

Qualified education benefits

Qualified tuition programs (QTPs, also known as section 529 plans because they are covered in section 529 of the IRS tax code) and Coverdell education savings accounts are grouped together in the law as qualified education benefits and have the same treatment: they are an asset of the owner (not the beneficiary because the owner can change the beneficiary at any time), except when the owner is a dependent student, in which case they are an asset of the parent. When the owner is some other person (including a non-custodial parent), distributions from these plans to the student count as untaxed income, as “money received.”

…

As long as distributions from QTPs and ESAs do not exceed the qualified education expenses for which they are intended, they are tax-free, so they will not appear in the next year’s AGI. They should not be treated as untaxed income (except in the cases mentioned above) or as estimated financial assistance. For more information on these benefits, see the IRS’s Publication 970, Tax Benefits for Education.

Workarounds

A 529 plan owned by the grandparent or other third party can

hurt the student’s eligibility for need-based financial aid. There are

a few workarounds to address the treatment of such a 529 plan.

1. Wait until the senior year in college to take a distribution from

the 529 plan. Since there will be no subsequent year’s FAFSA to be

affected (assuming the student does not plan on enrolling in

graduate school), it will not affect eligibility for need-based

aid. Technically, the distribution can happen as early as the

spring of the junior year in college, since that will occur after

the calendar year upon which the senior year’s FAFSA is based.

2. Change the account owner to the student or the student’s

parent. However, some state plans do not permit a change in

ownership, so it may be necessary to move the money to a different

state’s plan before changing the account owner.

3. Wait until after the student has graduated to take a non-qualified

distribution (say, to pay down student loan debt). The income tax and

tax penalty on the earnings portion of a non-qualified distribution

are not as severe as the loss of need-based aid eligibility from

treating the distribution as untaxed income to the student.

PROFILE Form Counts Grandparent-Owned 529 Plans as Assets

The CSS/Financial Aid PROFILE Form has a different treatment of 529

plans. All 529 plans that name the student as a beneficiary are

reported as assets on the PROFILE. (The PROFILE also considers assets in

the name of siblings who are under age 19 and not yet enrolled in

college.) So a grandparent-owned 529 plan will be reported as an asset

on the PROFILE.

Source: Fastweb

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