unclear for grandparents' 529 plan
College Money Guru,
I just read your column about a parent saving for a child's education
using a 529. What if it is a grandparent that opens the account?
My parents want to open a 529 account for my son with $100,000.
I am a single mom; the father has not seen my son since 1996. My
sole source of income is Social Security disability because of multiple
sclerosis. How will this affect the financial aid situation for
college for my son if they open a 529?
I can understand your concern. Based on your
limited income, and assuming your nonretirement financial assets
are modest, it is likely that your child will be eligible for federal
grants, subsidized loans for college or both. The generous actions
of grandparents or other relatives in helping to pay for college
can cause a reduction in financial-aid awards.
The good news for you is that the federal student-aid application,
or FAFSA, does not ask about assets belonging to anyone other than
yourself and your child, even when those assets are set aside to
help pay for your child's college. This means that grandparents
can open 529 accounts without being concerned about how the value
of those accounts will impact federal-aid eligibility.
There is some uncertainty, however, surrounding the
treatment of a grandparent's withdrawal of 529 funds when those
funds are actually used to pay for college. Some experts feel that
when a grandparent hands over the money to the student or to the
parent on behalf of the student, it must be included on the FAFSA
as base-year income, just like any other cash support provided by
the grandparent to the student. The base-year income reduces financial-aid
eligibility for the following school year. The consequences would
be even more severe if the grandparent were to direct the 529 plan
to make payments directly to the educational institution, as these
payments would reduce financial aid on a dollar-for-dollar basis.
The counterargument is that Congress and the U.S.
Department of Education did not intend that financial-aid eligibility
be reduced by tax-free withdrawals from 529 plans, regardless of
account ownership and method of payment. The support for this argument
comes from a poorly worded letter issued by the U.S. Department
of Education in 2004.
So what should you and your parents do in light of
this uncertainty? To avoid the income issue, they could put their
money into a 529 plan naming you as the account owner. The problem
with this approach is that it then gets included in the eligibility
formula as a parental asset, albeit at a low rate of 5.64 percent
or less of the account value. Perhaps a bigger problem for your
parents is that they would be turning over control of their 529
money to you and would no longer have the option of taking it back
or redirecting it to other grandchildren in the future.
An alternative approach would be for your parents
to take withdrawals from their 529 accounts in the years during
which your child is attending school on a financial-aid package
but wait until after his last FAFSA is filed entering his senior
year before handing the funds over to you or your son. The 529 account
withdrawals should still qualify for the preferable income-tax treatment,
and the money can be used to pay down student loans or for other
purposes. Check with your tax advisers to make sure they concur
with this strategy.
Note that I have been describing the federal
financial-aid rules. Many private colleges (and some public colleges)
dispense their own aid to students based on alternative needs-assessment
formulas. Colleges may inquire about any 529 accounts held for the
benefit of the student and may consider those accounts when awarding
Finally, ask yourself if this financial-aid
discussion is even necessary. If your parents have the means, and
the desire, to fully fund your child's college education, why even
worry about the financial-aid consequences? Most financial aid comes
in the form of loans, not grants. You may not want to look into
this gift horse's mouth too closely.
To ask a question of the College Money Guru, go
to the "Ask the Experts"
page, and select "college financing" as the topic.