By Echo Huang, CFA, CFP®, CPA
You’ve saved and invested money in a 529 plan for years to pay for your son or daughter’s college education and the college enrollment time frame is coming up in the next year. Now that you’re getting ready to enter the “529 withdrawal phase”, you’ll want to be sure to make the right decisions when taking distributions from your 529 account. Here are your top three considerations:
- Learn how to take distributions to help you with financial aid. First, become familiar with the Free Application for Federal Student Aid (FAFSA) form. The way that a 529 plan is reported for dependent students, and counted for financial aid, typically depends on the owner of the 529 plan. Typically, a 529 plan owned by a custodial parent is counted as an investment and it may reduce need-based aid by a maximum of 5.64% of the asset’s value. Depending on your income, your 529 plan may or may not impact your child’s financial aid package. Withdrawals from 529 plans owned by the custodial parent, when used for qualified higher education expenses, are not typically counted as parent or student income. Typically, parents as owners of 529 plans get the most favorable treatments, so ideally the custodial parent should own the 529 plan.
If non-custodial, non-married parents, living separately or relatives (such as grandparents) own the 529 plan, then the assets are generally not listed on the FAFSA form. However, once the funds are withdrawn, the funds are considered to be the student’s untaxed income on the FAFSA form. Untaxed income can reduce the student’s eligibility for need-based financial aid by as much as 50% of the distribution amount, a much harsher impact than the 5.64% reduction based on the net worth of the parent assets. There are a couple of choices to consider: A. Before taking distributions, transfer the ownership to the parent or child as they both receive more favorable treatment for the 529 plan. B. Withdraw to pay for the senior year’s expenses and the treatment of income is irrelevant for applying for aid.