Simultaneously saving for college and for retirement can be a challenge for many families. A solution for some has been to ask for support from grandparents. We recently wrote about ways that grandparents can help pay for the increasingly expensive cost of a college education. One of those options is a 529 savings plan.
A grandparent-owned 529 plan can be a powerful resource for families with kids headed to college, because of the way these plans are treated in the process for applying for financial aid via the Free Application for Federal Student Aid (or “FAFSA”).
The FAFSA considers a parent-owned 529 part of parental assets, but a qualified distribution from the account is not considered income to the parent or the student.
In contrast, while a grandparent’s 529 plan is not listed on the FAFSA as an asset, a qualified distribution from the account is considered income in the subsequent year’s FAFSA, and assessed up to 50%, for the beneficiary student.
By way of example, if grandpa distributes $10,000 from his 529 to pay some college expenses for his granddaughter in 2020, the payment would be reported on the FAFSA she fills out in 2021. And, her financial aid award could be reduced by up to $5,000.
What’s the solution? Well, if possible, get grandpa’s 529 distributions to not show up on the FAFSA that affects the financial aid calculation.
First, note that several years ago the government lengthened the look-back time period for reporting income from prior-year to prior-prior-year.
Now, let’s look at another example. My daughter will be starting college in the fall of 2021 (she’s a high school junior this 2019-20 school year). She can submit a FAFSA application for her first year of college as early as October 2020. So, distributions for her from 529 plans in 2019 will be reported on that form. And assuming she completes her college studies in four years, she’ll fill out her final FAFSA form in October 2023, and it will reflect 529 distributions in 2022.
If one of her grandparents – say, my dad – waited to start making 529 distributions for her college expenses until January 2023 – halfway through her sophomore year – they wouldn’t show up on a FAFSA and wouldn’t impact her financial aid calculation.
One caveat for this strategy is that if my daughter wants to attend graduate school and thus fill out more FAFSA applications, her grandfather’s “wait to pay” strategy may need to be extended. And he may be unable or unwilling to do so.
What if grandpa insists on helping her right away and isn’t able to delay his support?
Well, one option might be for her grandpa to own the 529 plan account – that isn’t reported on my daughter’s FAFSA – until a financial aid award letter has been received. Then, he can make a partial change of ownership on his 529 account.
For example, if a year of college costs $50,000 and $30,000 of need-based aid is awarded, the funding “gap” is $20,000. An equal amount of the grandfather’s 529 plan’s assets could be changed to the parent’s ownership. As the parent, I can then make a qualified $20,000 distribution from the 529 to pay the remainder of the cost, and not generate any income for the student.
With this strategy, it’s important to make sure that the 529 plan administrator won’t treat a partial ownership change as a taxable event. And, as always, you should discuss the potential tax ramifications with your accountant or tax advisor.
Questions?
If you have any questions about saving for college while also getting ready for retirement, feel free to give us a call on (888) 998-4796 or send an email to questions@springwaterwealth.com. We’d love to help!
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