529 Plan Benefits: Aid Formulas

My last post highlighted some of the tax benefits of 529 plans. One of the lesser-known benefits is that 529 plans get preferential treatment on the FAFSA. How? A couple of ways.

First, the FAFSA and CSS PROFILE both treat 529 plan balances as parental assets, not student assets, even though they are technically considered completed gifts to the beneficiary (which is great for grandparents hoping to remove assets from their estates). If you remember how the formulas work, parental assets are assessed at 5.6% of their actual value, AFTER an asset protection allowance (based on the parents’ ages) is subtracted. 20% of all the student’s assets are considered available for college. So a $10,000 529 plan balance might add nothing to your EFC, whereas the same amount in an UTMA account (which is considered the student’s) would add $2,000 to your EFC.

Of course, assets are the smaller part of the formula; income is the big one. Here’s another big advantage to 529 plans: withdrawals are not counted as income on the FAFSA. Let’s say you invested $10,000 for college and over time it grew to $20,000. That means you contributed $10,000 and have a gain of $10,000. If that money were in a 529 plan and you spent it for college one year, the $20,000 that you withdrew would, for FAFSA purposes, simply be subtracted from your assets the following year. No tax due and no additional income to report from the gain.

If that $20,000 were in a brokerage account, you would incur several penalties: First, you’d pay capital gains taxes on the $10,000 gain. Assuming it’s long-term, you would pay $1,500 in federal taxes plus applicable state taxes. Then, on the following year’s FAFSA, that $10,000 gain would be reported as income. That income would increase your EFC by as much as $4,700. So your $10,000 gain would cost upwards of $6,000, leaving you with not $20,000 but less than $14,000.

Yay, 529 plans!

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