As college costs increase, more and more students are depending on 529 college saving plans, as well as expecting to qualify for federal financial aid. For those students fortunate enough to have family members that are able to help contribute to a plan account, the question often arises as to who should own the account—a grandparent, a parent, or the child themselves?
This question becomes difficult to answer when the student also needs to qualify for federal financial aid. To compound it even further, the PPY rule (“prior prior year”) was passed in 2015. Going into effect starting in fall 2017, it will impact students qualifying for financial aid as this rule looks back two years to look at income to help determine federal financial aid. So, who should be the 529 account owner?
Parent-owned – If the 529 plan account is owned by the parent, it is considered a parental asset for financial aid purposes. 5.64% of the value of the account is annually considered to be counted towards the Expected Family Contribution (EFC) and is considered on the FAFSA (Free Application for Federal Student Aid). Although qualified tax-free distributions are not counted as income for the EFC calculation.
Student-owned – In this scenario, the student is considered the account owner and beneficiary. As long as the student is a dependent of the parent, the account is also considered to be an asset of the parent and would have the same EFC impact on the FAFSA. Qualified, tax-free distributions are not counted as income for the EFC calculation.
Grandparent-owned – Many families have opened 529 plans that are owned and controlled by the grandparent. This account would not be considered an asset of the student. The balance of the account does not require an EFC calculation, although qualified, tax-free distributions are considered income. This would be the recommended option for a younger child who has many years until college. Here, the contributions grow tax deferred and the grandparent can reduce their taxable estate through gifts. If possible, funds from the grandparent-owned 529 plan should be accessed and used during the last two years of college (due to the “prior prior rule”).
If the grandchild is older and ready to attend college, it is most beneficial to have the grandparent make the tuition payment directly to the college institution. This reduces the grandparent’s own taxable estate, does not count towards their annual gift tax
exclusion (currently $14,000), and does not impact
qualifying for financial aid.