Financial planning is one of a multitude of reasons investors seek the help of a financial professional. Learn how SmartAsset AMP can connect you with prospective clients.
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
A 529 plan can influence financial aid eligibility and the amount awarded. While these savings plans are valuable for covering education expenses, they are considered parental assets on the Free Application for Federal Student Aid (FAFSA). As such, they can reduce the amount of need-based financial aid a student may receive. However, while a 529 plan may slightly decrease financial aid eligibility, it still remains a beneficial tool for college savings.
How a 529 Plan Works
A 529 plan is a tax-advantaged savings account created to help families prepare for future education expenses. Named after Section 529 of the Internal Revenue Code, 529 plans are offered by states, state agencies or educational institutions. They are primarily used to pay for qualified education costs such as tuition, fees, books and, in some cases, room and board at colleges or other post-secondary institutions.
One of the main benefits of a 529 plan is its favorable tax treatment. Earnings grow tax-free, and withdrawals are also tax-free when used for qualified educational expenses. In addition, many states offer tax deductions or credits for contributions. This can further enhance long-term savings, and makes these plans particularly appealing for education-focused financial planning.
Setting up a 529 plan is simple. You can open an account through a plan provider and contribute as needed, with no annual contribution limit. However, total contributions must stay within the limits set to cover the beneficiary’s education costs. Many plans offer automatic contribution options, making it easier to build savings over time. Contributions aren’t limited to parents, either. Grandparents and other relatives can also contribute, and the account beneficiary can be changed if needed, offering added flexibility.
How Financial Aid Is Calculated
Calculating need-based financial aid begins with the Free Application for Federal Student Aid (FAFSA), a form that collects financial and household information about the student and their family. The FAFSA now generates a Student Aid Index (SAI) instead of the former Expected Family Contribution (EFC).
The SAI serves a similar purpose: It helps colleges determine how much financial aid a student may need by estimating the family’s ability to pay for college.
Several key factors influence the SAI:
-
Income. Both the student’s and parents’ income are assessed, with higher income typically resulting in a higher SAI and reduced eligibility for need-based aid.
-
Assets. This includes savings, investments and other non-retirement assets (excluding the value of the family home). Student-owned assets are still weighed more heavily than parental assets.
-
Family Size. A larger household may reduce the SAI, as it reflects greater financial responsibility.
-
Number in College. Unlike in the past, the number of family members attending college is no longer factored into the SAI calculation. This change may reduce aid eligibility for families with multiple students in school at the same time.
Once the SAI is calculated, financial aid offices compare it with the cost of attendance (COA) at their institution, which includes tuition, fees, room and board, books and other related expenses.
Financial Need = Cost of Attendance (COA) – Student Aid Index (SAI)
This formula helps schools determine how much need-based aid a student may receive.
How 529 Plans Can Impact Financial Aid Calculations
As we mentioned above, FAFSA now uses the SAI to assess a family’s ability to pay for college, replacing the previous EFC. The treatment of 529 plans in this calculation depends largely on who owns the account.
Parent- or Student-Owned 529 Plans
-
Assessment Rate: When a 529 plan is owned by a parent or dependent student, it is considered a parental asset on the FAFSA. These assets are assessed at a maximum rate of 5.64% in the SAI calculation. That means a $10,000 529 plan would increase the SAI by up to $564, according to AP News, potentially reducing need-based aid by that amount.
-
Withdrawals: Qualified distributions from these accounts are not counted as income on the FAFSA, so they do not affect financial aid eligibility in subsequent years.
Grandparent- or Third-Party-Owned 529 Plans
-
Previous Rules: Under prior FAFSA rules, distributions from grandparent-owned 529 plans were considered untaxed student income, which could reduce aid eligibility by up to 50% of the distribution amount.
-
Current Rules: Starting with the 2024–2025 academic year, the FAFSA no longer requires students to report cash support or distributions from grandparent- or third-party-owned 529 plans, according to Kiplinger. These distributions are excluded from the financial aid calculation, eliminating the previous penalty.
Considerations for Institutional Aid
While the FAFSA no longer counts grandparent-owned 529 plan distributions, some colleges use the CSS Profile to award institutional aid. The CSS Profile may still consider these distributions, so it’s important to check the specific policies of each institution.
Jeff White is an Editor for SmartAsset. He's an expert in a variety of personal finance topics, such as investing, banking and retirement, and also holds the Certified Educator in Personal Finance (CEPF®) designation. Jeff has received his JD and MBA and has been featured in a number of publications, such as Investopedia, The Street, Forbes, Yahoo! Finance and more. He currently resides in Utah with his wife and five children, where they cheer for the Denver Broncos and make it to the water to sail whenever given the chance.
SmartAdvisor helps qualified financial advisors build meaningful relationships directly with mass-affluent consumers who are actively searching for financial advice. Learn more about how our platform can help grow your practice.
A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out some of our webcasts.
More 529/College Planning Topics >
Financial planning is one of a multitude of reasons investors seek the help of a financial professional. Learn how SmartAsset AMP can connect you with prospective clients.