28 Sep Grandma’s 529 plan can hurt financial aid

Q. My parents saved in a 529 for my son and never told me about it. We’re going to soon apply for financial aid and I’m worried it could hurt his chances. What can we do?
— Mom

A. Your parents’ generosity is wonderful, and it’s a good thing they told you about the account.

Here’s where that account will come in.

The first step in determining financial aid eligibility is to estimate your Expected Family Contribution (EFC), said Peter McKenna, a certified financial planner with Highland Financial in Riverdale.

The EFC is the amount that is calculated as part of the Free Application for Federal Student Aid (FAFSA) and forms the baseline for most need-based financial aid, he said.

“The EFC is the figure that the FAFSA calculation determines as the amount that the family can pay towards education expenses for the coming year,” McKenna said.

The calculation assumes that 22 to 47 percent of parental income and roughly 6 percent of parental assets (excluding retirement accounts and primary home equity) are available each year for college, McKenna said. Student income and assets are assessed at higher percentages once they are over certain threshold values.

“Most families find the EFC figure to be significantly more than they realistically afford to pay each year, McKenna said.

There are a number of resources on the web that can help you calculate the EFC.

“You will need your most recent tax return, the value of any investments you might have and a few other documents,” he said. “If your EFC is higher than you expect and not materially lower than the cost of attending the schools he is considering he may not be eligible for need-based financial aid.”

McKenna said if your son may be eligible for need-based aid, a 529 plan that is not owned by the parent or the student will not be counted in the federal EFC formula for the first year. Because the 529 balance is owned by the student’s grandparents, it is not an asset of the student or the parent.

But it gets tricky beyond the first year.

The FAFSA needs to be filled out each year and if you son receives money from a 529 account owned by anyone other than his parents, it is put into the EFC formula as student income, McKenna said.

“If your son was eligible to receive need-based financial aid in his first year, it is entirely possible that the withdrawals from the 529 would reduce or eliminate his aid for subsequent years,” he said. “Some families get around this issue by delaying any non-parental 529 account withdrawals until after the last FAFSA is filed, e.g. after January of the student’s junior year in college.”

There is some other bad news to consider.

McKenna said while the federal formula excludes 529 accounts owned by other people, many schools have their own institutional formulas for calculating need-based aid. Some of these will ask if the student is the beneficiary of any trusts or 529 accounts that are not owned by the parent.

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This post was first published in September 2016.