How a 529 Plan Affects Financial Aid Eligibility

A 529 plan is a great way for families to save for college, while taking advantage of various tax benefits. One of the biggest perks is that 529 earnings grow tax-free, and any qualified education expenses can be paid for with tax-free withdrawals.

But when planning for future college costs, you might wonder, “Does a 529 affect financial aid?”

A 529 account can affect financial aid awards, but as long as it’s a parent-owned account (or owned by a dependent student), it’ll only have a minimal impact that’s far outweighed by the benefits of having access to college savings.

Read on to learn about how a 529 plan is factored into the Free Application for Federal Student Aid (FAFSA).

529 and financial aid eligibility

529 plans have many pros and cons, but one area that’s often overlooked revolves around future financial aid eligibility.

To better understand why 529 plans play a role in financial aid, let’s first look at how financial aid is calculated.

In simplest terms, financial aid is determined by:

Total Cost of Attendance (COA) – Expected Family Contribution (EFC)

The COA is determined by the college and includes tuition and fees, room and board, and books and supplies. But what is EFC, and how is it calculated?

Although EFC might stand for “expected family contribution”, it’s not an accurate representation of how much families can or will contribute to their child’s education.

Instead, EFC is a formula that uses the information provided on the FAFSA to determine students’ eligibility for certain types of federal student aid. This formula factors in a family’s income and assets, household size, dependency status and a whole slew of other data points.

And included in this complex formula are details about the assets available in a 529 plan account.

2021-2022 EFC formula

Without going into overwhelming detail, here are some of the basics of the EFC formula for the as it pertains to 529 plans.

The EFC assumes that students will receive funding for college from several primary sources, including their parents’ income and assets, and their own income and assets — with the biggest factor being income.

But a family’s assets can chip away at their student’s financial aid eligibility. Fortunately, there’s an “Education Savings and Asset Protection Allowance” that shields a part of 529 savings based on students’ age.

For example, if your parents are married and are 45 years old, you’ll receive a college savings allowance of $6,200. And the allowance is highest for parents age 65 and older, capping out at $10,500.

After accounting for the asset protection allowance, the value of your 529 plan is assessed at the following maximum rates:

• 5.64% for parent-owned 529 accounts. If the account is owned by a dependent student, the savings are still treated as a parental asset.
• 20% for 529 accounts owned by independent students. Independent students’ savings are generally treated as student assets.

Additionally, there are various exclusions and allowances that can further minimize the effect of income and assets on financial aid eligibility. This includes factors like whether you meet certain income thresholds or have received federal public assistance in the previous two years.

You can review the 2021-2022 EFC Formula Guide for a detailed breakdown of worksheets and tables used to calculate an estimated EFC.

NOTE: The EFC will be replaced with a new student aid index (SAI) beginning the 2023-2024 academic year. Although it’s primarily a name change to better reflect its purpose, its underlying formula will better address the financial needs of college families.

Be mindful of third-party owned 529 accounts

Third-party 529 accounts, such as those owned by grandparents or other family members, have more of an impact on financial aid eligibility. Here’s why.

The assets held in a grandparent-owned 529 account won’t initially be included in the student’s FAFSA calculations. But any withdrawals made to pay for their college expenses will count toward the student’s income, which is assessed at 50%.

So, let’s say a grandparent withdraws $8,000 from their 529 account to help pay for the student’s college tuition. This will reduce the student’s eligibility for financial aid by as much as $4,000.

One way to avoid this situation is to wait to make withdrawals until the student is further along in their college experience.

The FAFSA uses financial information from the prior-prior year, meaning income from two years ago. Therefore, families can strategically plan to use grandparent-owned 529 savings once it no longer affects the student’s FAFSA in the final semesters of college.

Is a 529 plan worth a possible financial aid reduction?

Although your child’s financial aid eligibility could be impacted by your 529 savings, it’s still worth making the investment.

Look at it this way. Would you turn down a higher income just because you might pay more in taxes? Probably not. More income means you can live more comfortably, even if it costs you a little on the back-end.

The same applies to saving for college.

It’s better to prepare and save what you can over time, so your child has access to more funding sources when the time comes. More college savings means your child doesn’t have to borrow as much with student loans, even if it costs them a little in financial aid later down the road.

Plus, financial aid award packages often fall short of the money that’s actually needed to attend school. So, it’s better to reap the benefits of tax-free growth instead of planning for a financial aid package that might not come through in the end.

How to get started with a 529 plan

Opening and contributing to a 529 plan is easy once you decide which plan is right for you.

Every state (excluding Wyoming) offers its own 529 savings plan to both residents and non-residents. But only certain states provide additional state tax benefits that could sway your decision.

Additionally, each 529 plan has contribution limits and various investment options. So, it’s best to weigh your options based on your financial goals.

Start by visiting your state’s website to review its 529 savings plan. And then compare what other plans have to offer.

College Savings Plans Network provides many resources to help you research college savings plans. Or you can let an adviser platform like CollegeBacker do the legwork for you.