Will a 529 Plan Affect Financial Aid Eligibility or Amount Awarded?

A 529 plan can affect a student’s eligibility for need-based financial aid. Whether or not it does depends on factors such as account ownership and the family’s finances. For a dependent student, a parent-owned 529 is generally included as part of the parents’ assets on the Free Application for Federal Student Aid (FAFSA). Accounts owned by grandparents or other people, meanwhile, follow different rules.

Do you need help with financial planning for your child’s college education? Consider talking to a financial advisor today.

How a 529 Plan Works

A 529 plan provides a tax-advantaged way to put money aside for a beneficiary’s education. States, state agencies and educational institutions sponsor these plans, which take their name from the section of the federal tax code that governs them. Beneficiaries can use the funds for eligible education costs, including certain expenses associated with college and other qualifying schools.

Federal income tax generally isn’t due on investment growth while the money remains in the account. Distributions are also generally free from federal income tax when they pay for qualified educational expenses. Depending on where you live and which plan you use, contributions may also qualify for a state tax deduction, credit or other benefit.

Federal law doesn’t set a specific annual contribution ceiling for 529 plans. Instead, individual programs establish maximum account balances. Parents aren’t the only people who can fund an account. Grandparents and other individuals may contribute, though contributions can have gift tax consequences. If plans change, an account owner can generally name a different eligible beneficiary.

How Financial Aid Is Calculated

Students seeking federal financial aid must submit the FAFSA. This form uses information about the student and, when applicable, the student’s family to produce a Student Aid Index (SAI). This index helps determine federal student aid eligibility. For a dependent student, the calculation can incorporate both student and parental financial information.

Several elements can affect the result:

Income: Student income and, for dependent students, parental income can enter the formula after applicable allowances.
Assets: Certain cash, savings and investments may be considered when asset reporting is required. A family’s principal residence isn’t treated as an investment for FAFSA purposes.
Family size: Household size can affect allowances used in the SAI calculation.
Family members attending college: Having more than one family member enrolled in college no longer directly lowers the SAI as it did under the former EFC methodology.

A college uses the SAI alongside its cost of attendance and other applicable financial assistance to determine a student’s eligibility for need-based aid. This formula helps schools determine how much need-based aid a student may receive.

How 529 Plans Can Impact Financial Aid Calculations

A child putting away money symbolically for college.

The effect of a 529 plan isn’t the same for every student. Ownership is particularly important because it determines whether the account is included among assets reported by the student or parents.

Parent-Owned 529 Plans

For a dependent student, money in a 529 owned by a parent is generally included with parental investments when the FAFSA requires asset information. A 529 that belongs to a dependent student is also generally reported with parental assets rather than assessed as a student investment.

Parental assets receive more favorable treatment in the federal aid formula than assets held directly by a student. However, the impact of a particular 529 balance is not the determining factor. Other reportable assets, income and allowances can also affect the SAI calculation.

Using money from a parent-owned 529 for qualified education costs generally doesn’t create student income that they then must report on a subsequent FAFSA.

Grandparent- or Third-Party-Owned 529 Plans

The FAFSA treatment of 529 accounts owned by grandparents or other third parties changed substantially with the redesigned federal aid application.

A grandparent-owned 529 isn’t reported as a parental asset because the student’s parents don’t own the account. Under older FAFSA rules, distributions from such an account could later be included as untaxed income received by the student. As a result, it had the potential to affect aid eligibility.

The redesigned FAFSA eliminates the question that led to the inclusion of those distributions as student income. As a result, a distribution from a grandparent-owned 529 generally doesn’t reduce federal aid eligibility.

Considerations for Institutional Aid

Federal aid rules don’t necessarily determine how a college calculates its own grants and scholarships. Some institutions use the CSS Profile or another application to collect additional information from students and their families.

A school using its own methodology may consider assets or financial support that don’t appear in the federal FAFSA calculation. Families seeking institutional need-based aid can review each college’s requirements before deciding how to structure or use education savings.

Strategic Planning Tips

Careful planning can also influence the impact of 529 plan funds on financial aid. Keep in mind the following:

Consider account ownership. Understand how the person who owns a 529 affects its treatment under the applicable financial aid system.
Time distributions strategically. Coordinate 529 plan withdrawals with qualified expenses and any education tax benefits that you’re claiming.
Be aware of institutional rules. Review a college’s requirements separately if it uses the CSS Profile or another financial aid methodology.
Get financial planning assistance. A financial advisor can help evaluate education savings alongside other financial priorities.

When 529 Assets May Not Affect the SAI

Having money in a 529 doesn’t necessarily mean the account balance will enter the federal aid formula. Some FAFSA applicants qualify for an exemption from reporting assets. Eligibility for this treatment depends on federal rules involving factors such as income, tax filing requirements and participation in certain means-tested benefit programs.

When the exemption applies, the FAFSA doesn’t use reportable assets in calculating the family’s SAI. A parent-owned 529 plan that otherwise would be reported with parental investments therefore may have no effect on the calculation for an applicant who qualifies for the exemption.

Federal rules governing which assets the SAI includes can also change between award years. Families completing the FAFSA should use the instructions for the specific academic year for which the student is seeking aid.

Bottom Line

A parent helping his daughter do homework.

The effect of 529 savings on financial aid depends partly on who owns the account and which aid formula a school uses. A parent-owned 529 may enter the FAFSA calculation as a parental asset for a dependent student. Meanwhile, a grandparent-owned account receives different federal treatment. When planning for college costs, weigh these rules against the account’s tax advantages.

Tips for Education Planning

A financial advisor can help you with many areas to do with financial planning, from college to retirement and more. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area. You can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Trying to figure out how much you’ll need to save for your child’s college? Consider this guide on how much you should save for college.