College savings FAQ: Does a 529 affect financial aid?

As parents, we all want what’s best for our children. Providing kids with the financial opportunity to seek higher education is a big priority for many parents, and for good reason! The cost of a college education is becoming more and more expensive, with the average total cost of attendance now reaching over $35,000 per student, per year. 

Fortunately, financial aid can often help students pay for school — but it usually doesn’t cover all of the cost. Many parents choose to save on behalf of their children, to help lessen the burden of increasing college tuition costs. 

One popular option is to use a 529 plan. These accounts offer significant tax advantages. But owning and using a 529 plan could potentially affect financial aid eligibility for the student. 

This guide explores the complex relationship between 529s and financial aid. 

What is a 529 plan?

A 529 plan is a tax-advantaged investment account that’s designed to be used to save for educational expenses. There are two types of plans: college savings plans and prepaid tuition plans. The 529 college savings plans are more popular, so this guide will primarily focus on them. 

Parents and guardians can open a 529 plan with their child as the beneficiary. They can then deposit money, invest, and watch the money grow tax-free. Earnings in a 529 are not subject to federal taxes, as long as the money is used on qualifying educational expenses. Many states also offer tax breaks for using 529s, although the details vary by state.

529 plans are primarily designed to help save for college and vocational schools. But the funds can also be used for tuition at private K-12 schools. However, most “qualified educational expenses” fall into the category of higher education. 

Qualified educational expenses include:

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• Tuition and fees at qualifying educational institutions (higher education and K-12)

• Books and supplies

• Computers, software, and internet 

• Room and board (student must be enrolled at least half time)

• Special needs equipment

• Student loans (up to $10,000 maximum)

Again, the tax perks of a 529 apply when the funds are used for the qualified expenses listed above. If funds are used for another purpose, taxes and penalties may be owed. 

How does financial aid work?

Financial aid is a broad term that refers to various types of aid for school. It typically includes grants, scholarships, student loans, and work-study. 

Most forms of federal financial aid are applied for via the Free Application for Federal Student Aid (FAFSA). This application needs to be submitted each academic year. 

The FAFSA gathers data on the income and assets of both parents and students, to calculate what is known as “Expected Family Contribution,” or EFC. The EFC is essentially what the government thinks a student’s family will be able to contribute toward their education, assuming that the student is considered a dependent student. 

The EFC, combined with data on the expected cost of college attendance, is then used to calculate how much federal financial aid is available to the student and what types of aid will be awarded in the financial aid package. 

The more income and assets a family has, the less aid the student will be eligible for. It’s a complicated formula, but the simplest way to look at it is that kids from lower-income families will typically qualify for more aid than those from higher-income families. 

The FAFSA considers income as well as assets when calculating EFC. For this reason, having money in a 529 plan can potentially affect financial aid eligibility. 

Does a 529 account affect financial aid?

529 plans can potentially affect financial aid eligibility in the following ways. 

529 plans are a reportable asset.

If the 529 plan is in the parent’s name, money held in a 529 plan will be considered a “parent asset” when calculating financial aid award eligibility. The FAFSA takes into account the assets that parents own (as well as their income). 

The way assets are considered in the EFC calculation is somewhat complex. Assets that need to be reported include cash, bank account balances, businesses, real estate, investments in brokerage accounts, and 529 plan balances. You don’t need to report retirement accounts, primary homes, or life insurance.

Since a 529 is considered a reportable asset on the FAFSA, money in a 529 can lower financial aid eligibility. But the effect is minor: Assets in the parent’s name only reduce a student’s net eligibility by a maximum of 5.64%. 

While nobody wants to miss out on financial aid, keep in mind that the tax benefits of a 529 almost certainly outweigh the minor penalty on financial aid eligibility. You may save more in taxes than you’ll be dinged when it comes to FAFSA awards. That said — everyone’s situation is different. Consult a tax expert to find out exactly how you’ll be affected.   

529 plan earnings are not reportable income on the FAFSA.

529 plans are considered a reportable asset. But in terms of a parent’s income, they are not used in the financial aid calculation.

This means that any earnings (profits) from a 529 plan aren’t considered income for the purposes of filing out the FAFSA. Profits in a 529 won’t affect financial aid eligibility at all when it comes to income. With that said, profits will increase the value of the 529 plan, which in turn increases the reportable assets.

For example, say a parent invests $5,000 in a 529. After several years, the value grows to $10,000. They won’t need to report that $5,000 profit as income, nor will the student — but they will need to list the current $10,000 account value under reportable assets.

529 plan withdrawals don’t affect financial aid.

Withdrawals (distributions) from a 529 plan are also not considered taxable income, as long as they are used for qualifying educational purposes. The student won’t need to report this money, and it won’t affect financial aid.

However, keep in mind that there may be tax consequences if you or the student uses the 529 funds for anything besides qualified educational expenses. 

How to improve a student’s financial aid eligibility 

Although a 529 can impact financial aid awards, there are still some ways to minimize any potential effect and to maximize the amount of aid that your child can qualify for. 

Be mindful of who owns the account. 

The account owner of a 529 plan can change how it affects the child’s eligibility for financial aid. 529s can be set up by parents, grandparents, or even put in the name of the child themselves. It’s typically most beneficial to use a parent-owned account. With grandparent-owned 529s, any withdrawals from the account will be considered untaxed income for the student — and will reduce aid eligibility. 

Apply for merit-based aid.

Keep in mind that 529 plans only affect need-based financial aid, like grants. They do not affect eligibility for merit-based aid, such as scholarships.

Consider student loans.

Student loans are available to most students, regardless of their financial situation. While they are loans that need to be repaid, they’re still considered “financial aid.” 

Some federal loans are subsidized, so they don’t accrue interest while you’re in school. These subsidized loans are need-based, meaning they’re mostly available to students with greater financial needs. But unsubsidized student loans are available to all students, regardless of income or assets. 

Don’t sweat the small stuff.

Here’s the bottom line: 529s offer excellent tax benefits, and only have a minor effect on financial aid eligibility. If you’re still concerned, you can speak with a financial advisor, tax advisor, or financial aid counselor for more customized advice. 

529 plans are an excellent savings option for parents

There are a lot of great reasons to consider opening a 529 to save for college costs. Any potential effect on financial aid eligibility will be minor.

The earlier you start, the better! Consider this: Investing just $50 per month for 18 years may result in a balance of over $21,000, assuming 7%* average returns. 

And while you’re thinking about your child’s future, now is a great time to build on that momentum — with Greenlight. An all-in-one banking***, investment, and financial literacy app for kids and teens. Parents can get in on the action, too, with the Greenlight Family Cash Card, a credit card with up to 3%** cash back that you can auto-invest for college. Ready to start saving? Sign up for the Family Cash Card today!

*7% returns taken from the real total return of the S&P 500 Total and Inflation-Adjusted Historical Returns between 1950 and 2009.

**Earn 3% when you spend at least $4,000 in a billing cycle, 2% when you spend at least $1,000 but less than $4,000 in a billing cycle and 1% when you spend <$1,000 in a billing cycle. See the Credit Card Rewards Terms and Conditions for details, including earning, redemption, expiration, or forfeiture.

***Greenlight is a financial technology company, not a bank. The Greenlight app facilitates banking services through Community Federal Savings Bank (CFSB), Member FDIC.