Can Grandma’s 529 Plan Hurt My Kids’ Chances for Financial Aid?


Q: My parents saved in a 529 for my son and never told me about it. We’re going to soon apply for financial aid and I’m worried it could hurt his chances. What can we do? — Mom

A: Your parents’ generosity is wonderful, and it’s a good thing they told you about the account.

Here’s where that account will come in.

The first step in determining financial aid eligibility is to estimate your Expected Family Contribution (EFC), said Peter McKenna, a certified financial planner with Highland Financial in Riverdale, New Jersey.

The EFC is the amount that is calculated as part of the Free Application for Federal Student Aid (FAFSA) and forms the baseline for most need-based financial aid, he said.

“The EFC is the figure that the FAFSA calculation determines as the amount that the family can pay towards education expenses for the coming year,” McKenna said.

The calculation assumes that 22% to 47% of parental income and roughly 6% of parental assets (excluding retirement accounts and primary home equity) are available each year for college, McKenna said. Student income and assets are assessed at higher percentages once they are over certain threshold values.

“Most families find the EFC figure to be significantly more than they realistically afford to pay each year,” McKenna said.

There are a number of resources on the web that can help you calculate the EFC.

“You will need your most recent tax return, the value of any investments you might have and a few other documents,” he said. “If your EFC is higher than you expect and not materially lower than the cost of attending the schools he is considering he may not be eligible for need-based financial aid.”

McKenna said if your son may be eligible for need-based aid, a 529 plan that is not owned by the parent or the student will not be counted in the federal EFC formula for the first year. Because the 529 balance is owned by the student’s grandparents, it is not an asset of the student or the parent.

But it gets tricky beyond the first year.

The FAFSA needs to be filled out each year and if your son receives money from a 529 account owned by anyone other than his parents, it is put into the EFC formula as student income, McKenna said.

“If your son was eligible to receive need-based financial aid in his first year, it is entirely possible that the withdrawals from the 529 would reduce or eliminate his aid for subsequent years,” he said. “Some families get around this issue by delaying any non-parental 529 account withdrawals until after the last FAFSA is filed, e.g. after January of the student’s junior year in college.”

There is some other bad news to consider.

McKenna said while the federal formula excludes 529 accounts owned by other people, many schools have their own institutional formulas for calculating need-based aid. Some of these will ask if the student is the beneficiary of any trusts or 529 accounts that are not owned by the parent.

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Can We Pay Off Debt to Qualify for More Financial Aid?


Q. My daughter goes to college in one year. We’ve saved a lot in 529 plans and retirement accounts, and we only have about $45,000 in a brokerage account that would count against us for financial aid purposes. I also have $20,000 in credit card debt. Should I sell the stocks and pay off debt so we appear to have less cash for financial aid purposes? The brokerage money has no real goal.

A. Paying off debt can be a great thing, but let’s first talk about financial aid and how your assets will be considered.

The first step in the financial aid process is completing a form called the Free Application for Federal Student Aid, better known as FAFSA, said Michael Maye, a certified financial planner and certified public accountant with MJM Financial in Gillette, NJ. Roughly 300 schools also require another form known as the CSS Profile, which is short for the College Scholarship Service Profile.

We’ll focus on the more common FAFSA form and how it treats various assets for financial aid purposes.

“On a macro level, the FAFSA formula treats income/assets as follows: 20% of student’s assets (excluding 529s), 50% of student’s income after some allowances, 2.6% to 5.6% of parental assets based on sliding income and allowances, and 22% to 47% of a parent’s income based on sliding income and allowances,” Maye said.

These percentages are all important for the starting point for need-based financial aid — the calculation of the Expected Family Contribution (EFC) — which considers income as well as assets of both the parent and student, said Claudia Mott, a certified financial planner with Epona Financial Solutions in Basking Ridge, N.J.

“Neither mortgage debt nor consumer debt such as auto loans and credit card balances can be used to offset the value of investment assets in calculating the net worth, which is entered into the formula,” Mott said.

Now with your situation, Maye said, the 529 plans as a parental asset may reduce financial aid by a maximum of 5.64%, depending on your circumstances.

“In terms of the retirement accounts, it is good news as the calculation excludes retirement assets such as 401(k)s, IRAs and Roth IRAs,” Maye said. “However, if you tap a retirement asset to pay college bills — including a Roth IRA — that is considered income on the following year’s FAFSA.”

Maye said your brokerage account receives the same treatment as a 529.

Using your assets to pay debt can reap multiple rewards, Mott said.

“It may reduce the EFC, your cash flow should improve without the monthly payments and you will save the interest expense as well,” she said.

Assuming you have an adequate emergency fund, it likely makes sense for you to use the taxable brokerage account to pay off credit cards, Maye said.

“The primary reason it makes sense to the pay off the credit card debt is it eliminates a non-tax-deductible, high interest rate liability,” Maye said. “The fact that it might be helpful from a financial aid perspective is a secondary benefit.”

But, before you use your brokerage account to reduce the outstanding balance on your credit cards, be sure you understand the tax consequences of the decision, Mott said.

“The addition of possible capital gains to your adjusted gross income that aren’t fully offset by taxes might actually increase your calculated EFC,” she said. “You also don’t want to end up with a tax bill you hadn’t anticipated come next April.”

She recommends you speak with a tax professional to determine what, if any, capital gains might result from the sale and how that would affect your 2015 income tax profile.

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