According to Joe Hurley, founder of Savingforcollege.com, by far the most frequently asked questions he receives from advisors concern the impact of 529 plans on financial aid.
Here’s how Hurley responds to those questions:
- 529 plans compare favorably to other types of assets in the federal aid formula, in several ways;
- Income level is more important than assets in determining eligibility for need-based aid; and
- Advisors should consider whether their clients have a chance to qualify for need-based aid before getting too focused on that subject.
In the financial aid formula, a 529 plan owned by the custodial parent of a dependent student is assessed at a maximum 5.64% rate in determining the Expected Family Contribution (EFC) to college costs. A student's own investment assets, including UGMA or UTMA accounts, is assessed at 20%. Thus, $10,000 in a 529 plan might trim financial aid by $564 while that same $10,000 held by the student in an UTMA account could reduce aid by $2,000.
As Hurley points out, income can cut financial aid even more severely. Fifty percent of a student’s income (after certain allowances) is included in the EFC, and up to 47% of parents’ income. “Most investments used for college will impact the income side of the financial aid equation,” Hurley said.
“If you sell stocks or mutual funds, any gain is included as part of your 1040 income,” Hurley said. “If you earn interest on municipal bonds, the interest has to be added to 1040 income for the Free Application for Federal Student Aid. If you withdraw from an IRA, any portion that is not already included in 1040 income has to be added to 1040 income. None of that happens with a 529 plan: the tax-free income on a qualified withdrawal does not get added to 1040 income on the FAFSA.”
Unfortunately, according to Hurley, there are no simple rules-of-thumb on income or assets that advisors can use to estimate a client’s eligibility for college aid. He suggests using the Financial Aid Calculator on Savingforcollege.com to make a fairly accurate if not precise projection of financial aid eligibility.