You can contribute to a 529 plan for your grandchild in two ways:
1. The parent (or your grandchild) owns the account and you add money to it.
2. You own and fund the account, with your grandchild as the beneficiary.
If the parent/grandchild owns the account, you can deposit money in the account but you won’t have control over how the funds are invested or distributed. That’s up to the owner.
The good news: “Your gifts to a dependent-child or parent-owned 529 plan have a negligible impact on financial aid award eligibility,” says college financial aid expert Mark Kantrowitz, publisher of Edvisors Network, a group of more than a dozen websites about college admissions and financial aid.
Here’s why: 529 accounts owned by either a parent or dependent child are considered “parental assets” in financial aid calculations, and your contributions are part of that account. When it comes to determining financial aid awards, parental assets are treated quite favorably: Parents are only expected to contribute up to 5.64% of their assets toward college bills, according to calculations for the Free Application for Federal Student Aid (FAFSA).
Students, on the other hand, are expected to contribute 20% of their assets toward their college bills. A 529 plan owned by an “independent student” (no longer considered a dependent of his or her parents), is considered a student asset for financial aid purposes. So grandparent contributions to this type of 529 plan can reduce a grandchild’s financial aid options by up to 20%. Not terrible, but still something to consider.
If a grandparent owns a 529 account, the situation can be trickier. “These funds essentially have 10 times the impact on financial aid formulas compared to parental assets,” warns Kantrowitz. As of July 2009, money distributed from a grandparent’s plan to help pay a student’s college bills is considered “untaxed student income” and must be reported on the following year’s FAFSA form. Since students are expected to put half of their income (which is different from “assets”) toward college bills—50 cents of every dollar—this can significantly reduce their aid eligibility.
Kantrowitz suggests these options for improving your grandchild’s chances of getting grants, loans or scholarships if you own the 529 plan account:
Delay 529 plan withdrawals for your grandchild until after January 1 of his or her junior year in college. Your grandchild files his or her final FAFSA form that spring (reporting income and distributions from the previous calendar year), so your 529 distributions never need to be reported.
Transfer ownership of your 529 plan to a parent or your grandchild. If you have a significant amount saved in your plan or your grandchild needs your 529 funds sooner than the spring of her junior year, this is a good solution. If the parent or dependent child takes ownership of the account, it becomes a parental asset in financial aid formulas. If an independent child takes ownership, it becomes the student’s asset. In both cases, the plan will be counted more favorably in financial aid calculations than it would be if a grandparent owned it. Some states won’t allow you to change 529 account owners. In that case, Kantrowitz suggests transferring your plan to a state that does allow changes, then making the ownership transfer.
Set up a custodial 529 plan, with you as custodian and your grandchild as the owner/beneficiary. This works wells for grandparents who want control of 529 funds and distributions, but don’t want to impact financial aid. Custodial accounts are technically considered a parental asset in financial aid formulas (again, favorable treatment), even though parents have no control over the account.
Since these 529 decisions can be complex, check with your financial or tax advisor to be sure you understand your choices and their implications.
Used with permission from Dow Jones 5/20/13