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Questions About Your 529 Plan You Were Afraid to Ask

| October 18, 2019
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This fall I have had many friends drop their oldest child off at college for the first time.  Some have shared the excitement of this next step, others the chaos of setting up the dorm room, and for others the loneliness of coming home to a quieter house.   One topic they ALL shared, however, was the trials and tribulations of navigating how to pay for college – be it savings, aid, loans, or scholarships.   

In Massachusetts we are very fortunate to have a MEFA – the Massachusetts Educational Financing Authority.   This organization is a wealth of information for both parents and students.  I recently sat down with Julie Shields-Rutyna, the Director of College Planning and asked her a few questions about paying for college that I would like to share with you.

Q: Do 529 Savings Plans negatively impact my child when applying for financial aid?

A: A 529 college savings account will help you much more than hurt you!  A 529 plan established by a parent is considered a parent asset by the financial aid formula and good news - that formula treats parent assets quite favorably.  You DO have to report all of your non-retirement savings, but the formula considers at most 5.6% of your assets per year as available to help pay for college costs.  This means almost 95% your savings will be protected within the formula! 

The benefits of a 529 plan are many, including:

  • Reduce, or eliminate, the need to take out loans
  • Student can spend more time studying and less time working
  • Growth and qualified distributions are tax free
  • Allow for more options in college choice

Q: Suppose I have been able to save $50,000 for my child’s education.  Can I distribute this money across all four years or do I have to use it all up front?

A: You can use the money across as many years as you like.  After you receive the financial aid offer from the college your son or daughter has chosen, you have to calculate the balance due to the school.  You have the option to meet this balance using any combination of savings, current income and loans available to you.  Every family will make a unique choice each year.  Some families may decide to allow their savings more time to grow and choose to use it later, while other families may choose to use it all up front, and yet other families will choose to spread the savings across many years.  It is your money and you can choose when to take distributions.

 

Q: What if I overfund a 529 account?  For example, what if my child gets a scholarship and I do not end up needing all of it.  Do I have to pay a penalty, or can I transfer the account to another one of my children?

A:  Congratulations on the scholarship!  Fortunately, you many options to avoid paying taxes and a penalty on your earnings, you could:

  • Keep the money in the account to be used for graduate school
  • Change the beneficiary to another qualifying family member (in this case, a sibling)
  • If you have a younger child, under the tax law changes of 2017 parents now have the option to take up to $10,000 in tax-free 529 withdrawals for K-12 tuition
  • Use the money to go back to school, by changing the beneficiary to yourself
  • If this is applicable, you can roll over the funds to a 529 ABLE account, which is a savings account specifically for people living with disabilities

If these choices don’t apply, and you take a distribution of the remaining money the earnings portion of non-qualified withdrawals may be subject to Federal and State income tax as well as a 10 percent penalty.  There are a few exceptions to this rule including if a student earns tax free scholarship, the beneficiary dies or becomes disabled, or the student attends U.S. military academy.   

Q: Should my child’s grandparents open a 529 in their name instead of contributing to one established by us, the parents?  I have heard this may help my child qualify for more financial aid at first, but then going forward those distributions are treated as income for my child.  Is this true?  What if the grandparent passes on before kids are in college?

 

A: There are a number of considerations when deciding if this situation will work for your family.  It’s wonderful for grandparents to help save for college for their grandchildren.  If the grandparent contributes to a 529 plan established by the parent, the grandparents need to understand that that those assets will be treated as parent assets and assessed at 5.6% in the financial aid formula.  If, on the other hand, the grandparent chooses to open a 529 plan themselves, he or she needs to understand that those assets are not factored into the financial aid application of the student until they are withdrawn and used for the benefit of the student.  Depending on when in the student’s college experience, the grandparents withdraw funds to pay, this may or may not affect future financial aid for the student.  Included in the calculation for financial aid are “monies paid on your behalf” which then considers these funds as student income.  Grandparents and parents should discuss these options up front and have a good understanding of how this may or may not affect financial aid.  It is important to have this discussion before the 529 account is opened.

Most 529 applications require that the account owner name a successor owner.  The successor owner is someone designated by the owner to assume control of the account should the owner pass away or become otherwise incapacitated.  If a grandparent were to pass before the beneficiary uses the money in the 529 account, the successor owner would then be involved in all decisions about when and how the distributions are made.

 

Julie Shields-Rutyna – Director of College Planning, MEFA

Julie joined MEFA in 2007 and in her role provides expertise related to planning, saving, and paying for college to families, colleges, and other organizations.  Prior to joining MEFA, Julie worked for the College Board, Nellie Mai, and American Express, and was the Director of Financial Aid at the Harvard Graduate School of Education.  Julie has been involved with MASFAA in a variety of positions and committees since 1993.  She holds degrees from the University of Massachusetts in Amherst and the Harvard Graduate School of Education in Cambridge.

Prior to investing in a 529 Plan investors should consider whether the investor's or designated beneficiary's home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state's qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.

MEFA is not affiliated with LPL Financial or Atlas Wealth Strategies.

The opinions voiced in this material are for general information only are not intended to provide specific advice or recommendations for any individual.

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