Funding a 529 plan is a great way to put money toward your child’s college expenses. It works like a Roth IRA, but for educational purposes. You can’t deduct your contributions on your taxes, but you get tax-free growth and withdrawals as long as the distributions are for IRS-approved educational expenses.
But if you expect your child to qualify for financial aid, you may be concerned about the impact on their award. Read on to learn more.
Do 529 plan assets affect financial aid?
In short, yes. But the impact will be minimal.
Your child’s financial aid will be based on the information you provide on the Free Application for Federal Student Aid (FAFSA), which takes into account both parent and student income and assets. If you open a 529 plan for your child, you will be the owner and your child will be the beneficiary. 529 plan money is considered a parent-owned asset.
However, assets owned by parents have a relatively small effect on financial aid. Parental assets (we’ll explain what does and doesn’t count) will reduce the student aid award by no more than 5.64% of the asset’s value. In other words, if you have $10,000 invested in a 529 plan for your child, their financial aid would be reduced by a maximum of $564 (and often less).
Income is much higher for financial aid. Parents can be expected to invest between 22% and 47% of their disposable income on their children’s education. (Note that “disposable” income and total income are two different things. Disposable income can be negative in some circumstances.)
One of the biggest advantages of a 529 plan is that distributions are not considered income unless they are taken for qualified education expenses such as tuition, fees, books and supplies.
What else is considered a parental asset?
Many other parental assets are off-limits in FAFSA calculations, including retirement accounts, private family residences, life insurance policies, and annuities. However, bank and brokerage accounts, cash, real estate that is not a principal residence, and the net worth of businesses with 100 or more employees will be considered parent assets.
However, it is especially important for parents to consider that retirement accounts won’t happen count as assets distributions from retirement accounts will count as income. And remember, income reduces financial aid much more than assets.
Parents often debate whether to save for college in a Roth IRA versus a 529 plan because Roth IRAs allow penalty-free distributions for higher education. Although the account itself will not count as an asset, any distributions from the Roth IRA will still count as income for college financial aid purposes. That’s a big argument for saving for college with a 529 plan instead of a Roth IRA.
Should you invest in a 529 plan?
If you can afford to invest in a 529 plan for your children, it’s usually a smart move. Getting started as early as possible is important, given that college costs typically increase at a higher rate than general inflation.
An added benefit of 529 plans? Beginning in 2024, parents will be able to roll over up to $35,000 of unused 529 plan savings into a Roth IRA for their child. That means even if your child doesn’t need all that money for college, you can still use those funds to get them started on retirement savings.