Will grandma’s 529 plan hurt student’s financial aid?

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Q. We have been funding our granddaughter’s college fund almost since she was born. It now holds $100,000 and she still has two years of high school left during which we planned to continue contributing to the account. She is a very good straight A student and plans to apply for scholarships to help with college. A financial advisor just told us to stop funding the college account because it will greatly decrease her ability to obtain a scholarship. Is this true? Have we done a bad thing by setting up this account?
— Grandma’s dilemma

A. Family members often put money into a college fund for a loved one, but they don’t always realize that those accounts can have an impact on financial aid.

The first item to consider is what type of account do you have set up for your granddaughter.

If it is a custodial account, for financial aid purposes, the assets are treated as the student’s assets regardless of who owns the account, said Victor Cannillo, founder of Baron Financial Group in Fair Lawn.

Therefore, it could have a great impact on their financial aid eligibility.

There could good news if you funded a 529 plan.

“529 plans that are in a grandparent’s name will not show up on the Free Application for Federal Student Aid (FAFSA) in the `parental asset or resources’ section,” Cannillo said. “However, if distributions are made from the account while the child is in school, they will be considered `income’ and may have a large effect on the FAFSA form.”

Cannillo said financial aid based on the FAFSA form does distinguish between parent-owned and grandparent-owned 529 plans.

“If a 529 college savings plan is owned by a dependent student or by a dependent student’s custodial parent, it is reported as a parent asset on the FAFSA. Distributions are ignored,” he said. “But if a 529 plan is owned by anybody else, such as a grandparent, aunt, uncle, non-custodial parent, etc., it is not reported as an asset on the FAFSA. Instead, distributions count as untaxed income to the beneficiary.”

The important question is “how much effect” does the plan as an asset versus getting distributions have on the FAFSA.

If the 529 plan is reported as a parent asset on the FAFSA, it can reduce eligibility for need-based aid by as much as 5.64% of the asset value, according to SavingForCollege.com. Distributions from a 529 plan owned by anyone else — like a grandparent — will reduce eligibility for need-based aid by as much as 50% of the amount of the distribution.

“Based on this information and depending on your specific goals and situation for these monies, you may want to make sure all 529 plans are in the name of the child’s parents,” he said. “Anyone can still contribute to a child’s 529 plan.”

You also noted your granddaughter may be a scholarship student.

Cannillo said there are many kinds of scholarships out there that have their own restrictions and guidelines, so you would want to review those specifically.

“Academic-based scholarship is not affected by income, only need-based financial aid,” he said. “It would also be prudent to check with the specific college or university they plan to attend to review their financial aid policies.”

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This story was originally published on July 30, 2020.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.