How Does a 529 Plan Impact Financial Aid?

A 529 Plan is a tax-advantaged savings plan designed to help families save for education expenses, usually college. While these plans offer significant tax benefits, many families worry about how they might impact financial aid eligibility.

This article explains how 529 Plans can affect financial aid, like FAFSA and the CSS Profile, and shares tips to help reduce any negative impact.

Understanding Financial Aid and FAFSA

The FAFSA (Free Application for Federal Student Aid) is used by the government to assess a student’s eligibility for financial aid. After submitting the FAFSA, you receive a Student Aid Index (SAI), which determines your eligibility for federal grants, loans, and state aid. Many schools also use FAFSA data to decide on institutional aid.

Because of this, understanding how your 529 Plan affects your FAFSA is crucial.

How Does a 529 Plan Affect FAFSA?

The impact of a 529 Plan on FAFSA depends on who owns the plan.

1. Parent-Owned or Student-Owned 529 Plans:

• If the parent or student owns the 529 Plan, it must be reported as an asset on the FAFSA. The balance of the plan will be factored into the SAI calculation.
• The good news is that the withdrawal amount is not counted as income, which means that using the plan to pay for college expenses does not reduce financial aid eligibility.
• Since 2024-2025 FAFSA changes, the Asset Protection Allowance, which shielded some assets from being counted, has been reduced to zero, meaning all 529 balances must be reported.

Want to understand all the rules and benefits of a 529 Plan? Check out 529 Plan Rules: Everything You Need to Know.

2. Grandparent-Owned 529 Plans:

• 529 Plans owned by grandparents or other relatives do not need to be reported as assets on FAFSA. However, when the money is withdrawn and used for education, it is considered untaxed income for the student in the next FAFSA filing year.
• This can reduce the student’s aid by up to 50% of the withdrawn amount, which can be a significant penalty.

Reducing the Impact of Grandparent-Owned 529 Plans

If grandparents or other family members have a 529 Plan, there are ways to reduce the negative impact on financial aid:

• Gradual Rollover: Transfer small amounts of the grandparent’s 529 Plan to a parent-owned plan each year.
• Delay Withdrawals: Wait until the student has filed their last FAFSA before making large withdrawals.
• Change Ownership: Transfer the ownership of the 529 Plan to a parent to reduce the penalty to just 5.64% of the balance.

CSS Profile: A Different Story

The CSS Profile, managed by The College Board, is used by many private colleges to award non-federal financial aid. Unlike the FAFSA, the CSS Profile may count a grandparent-owned 529 Plan as an asset, which could impact the aid package.

Schools using the CSS Profile often take a more comprehensive look at family finances.

Reporting Earnings from a 529 Plan

One advantage of a 529 Plan is that the earnings (interest or investment growth) do not need to be reported as income on the FAFSA. This is beneficial because interest from other types of savings accounts does count as income and can significantly lower aid eligibility.

One major advantage of a 529 Plan is that the earnings (interest or investment growth) are not considered taxable income if used for qualified education expenses. Moreover, these earnings do not need to be reported as income on the FAFSA, unlike interest from standard savings or brokerage accounts. Learn more from IRS guidance on 529 Plans.

Practical Tips for Families

• Start Saving Early: The longer the money has to grow, the more benefits you get from tax-free investment growth.
• Strategize Withdrawals: Make sure withdrawals are timed carefully to minimize reporting as untaxed income.
• Consider Ownership Carefully: If grandparents plan to help with college expenses, discuss ownership and transfer strategies well before the student enrolls.

Frequently Asked Questions (FAQs)

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