Another graduation season has come and mostly gone, reminding us of the challenge of funding one of life’s great financial milestones. For families who still have a few years to mount that effort, a refresher on Section 529 college savings plans might be in order.
A 529 plan has some distinct benefits and strategic planning opportunities that reach across generations and financial objectives. The most salient of those income and estate tax advantages include:
- Dividends, interest, and capital gains accrue on a tax-deferred basis within the account.
- Withdrawals to cover qualifying education expenses are tax-free.
- Account assets are not considered to be part of an account owner’s estate for estate tax purposes.
Beyond those basics, there are other particulars to consider. Since most students receive some measure of financial aid, it can be important to understand how a 529 account affects a student’s aid eligibility.
Each year, those seeking aid complete the annual Free Application for Federal Student Aid (FAFSA), which gathers information on the income and assets of both the student and his or her parents. The FAFSA looks at a household’s income and assets to determine the Expected Family Contribution (EFC) from the student and parents. Colleges will look to meet the remainder of the costs of attending through some combination of grants, subsidized loans, and campus employment.
The first key is that the EFC does not draw equally from all assets and income. It looks to as much as 20% of student assets and 50% of student income. It calls on up to 47% of parent income while calling on only 5.64% of parental assets. A 529 account owned by a parent is considered a parental asset (for aid purposes), so only 5.64% of the 529 balance is drawn into the EFC – considerably more favorable than the 20% expected from a traditional custodial account (UTMA) which is deemed a student asset.
How might qualified withdrawals from a 529 affect aid? In addition to their tax-favored treatment, those distributions from a student- or parent-owned 529 account to pay for current-year expenses are not counted in the base-year income that would otherwise increase the subsequent year’s EFC.
What if grandparents or aunts and uncles get into the act? Assets in a 529 owned by anyone other than the student or his/her parents have no effect on the EFC calculation. However, withdrawals from such a 529 used to cover a student’s qualifying expenses are then included as student income (assessed at 50%) on the following year’s FAFSA. In general, these factors seem to suggest that parents and grandparents might prefer to hold assets in a 529 instead of endowing a UTMA account; and that parent-owned 529 assets be spent first with the grandparents’ 529 assets helping to cover that final year.
All that said, every family’s situation is different, and the above discussion is limited to federal financial aid. Colleges can make their own rules and introduce additional considerations in setting and administering aid. As has been widely publicized, an awful lot of financial aid is in the form of loans, to be paid back eventually by somebody. Saving is the key, and saving strategically can make a real difference.
Published by KMS Financial Services, Inc. * June 2017
2001 Sixth Ave, Suite 2801 • Seattle, WA 98121 • www.KMS.com
* Member: Financial Industry Regulatory Authority • Securities Investor Protection Corporation
Nothing contained herein shall constitute an offer to sell or solicitation of an offer to buy any security. Securities are offered through KMS Financial Services, Inc. Information in this publication is original or from published sources and is believed to be accurate. Readers are cautioned to consult their own tax and investment professionals with regard to their specific situations.