Latest / The College Savings Podcast with Fexingo: 529 Plans, Education Funding, and Student Costs / How 529 Plans Impact Financial Aid Eligibility
Transcript
- Lucas: So Luna, you know how we talk about 529 plans being the go-to tool for college savings. But one question I get all the time from parents is: 'Won't having this money hurt my kid's chances for financial aid?' And the short answer is: it depends, but probably less than you think. Luna: I hear that worry a lot too. So what does the math actually look like? Lucas: Under the current FAFSA formula — and this is for the 2026-2027 school year — a parent-owned 529 plan is treated as a parental asset. Parental assets are assessed at a maximum rate of 5.64 percent. That means for every ten thousand dollars you have in the account, only five hundred and sixty-four dollars is considered available to pay for college. Luna: That's surprisingly low. So the vast majority of that savings essentially doesn't count against aid? Lucas: Exactly. Now compare that to money held in the student's name, say a custodial account under the Uniform Transfers to Minors Act. Those are assessed at a flat 20 percent rate. So a ten thousand dollar account in the student's name would reduce aid eligibility by two thousand dollars — nearly four times more. Luna: Right, because the formula assumes students contribute a bigger chunk of their own assets. So the ownership structure is key. Lucas: Absolutely. And this is one of the big advantages of a 529. Not only do you get tax-free growth for qualified withdrawals, but you also get a much friendlier hand from the financial aid office. Luna: That's reassuring. And honestly, if today's conversation was worth a coffee to you, that's the link — buy me a coffee dot com slash fexingo. It keeps us ad-free and focused on content like this. Lucas: Yeah, listener support really makes this possible. So coming back to the FAFSA: there's another layer with the SECURE 2.0 Act. That allowed unused 529 funds to be rolled over into a Roth IRA for the beneficiary. But how does that interact with financial aid? Luna: I'd think rolling money into a Roth IRA would actually be beneficial for aid, since retirement accounts are generally excluded from the FAFSA. Lucas: That's right. The rollover counts as a qualified withdrawal from the 529, so it doesn't trigger a penalty. And the Roth IRA itself is not reported as an asset on the FAFSA. So if you end up over-saving, you can shift it to retirement without hurting aid. Luna: Nice marriage of tax and aid planning. But what about grandparent-owned 529 plans? Those used to be tricky. Lucas: They were a headache before the FAFSA simplification that took effect a few years ago. Previously, distributions from a grandparent-owned 529 were counted as untaxed income to the student, which could slash aid by up to 50 cents on the dollar. But now, with the simplified FAFSA, grandparent-owned 529 distributions are no longer reported as student income. Luna: That's a huge change. So grandparents can contribute to a 529 and the distributions won't ding the student's aid package at all? Lucas: As long as the distribution is used for qualified education expenses, yes. The new FAFSA simply doesn't ask about cash support from family. Previously, you had to time the distributions carefully — take them in the junior year after the FAFSA lookback period. Now it's much simpler. Luna: I have to imagine that makes estate planning for college much more straightforward. Lucas: It really does. But there's still a nuance: if the grandparent is the owner of the 529, the account itself isn't reported on the FAFSA at all, because it's not a student or parent asset. Only when money comes out — and now that's not counted — so it's a clean deal. Luna: What about state tax benefits? Some states offer deductions for 529 contributions. Could that interact with aid? Lucas: Indirectly. Many states also have their own financial aid programs, and some may have different asset treatment. But generally, the state tax deduction is an immediate benefit that reduces your state income tax, which can free up cash for other expenses. It doesn't directly affect federal aid formulas. Luna: Good to know. So the takeaway is: 529 plans are actually aid-friendly if owned by the right person. Lucas: Right. But there's one more thing I want to flag. A lot of families overlook the impact of 529 plans on merit-based aid versus need-based aid. Some colleges, especially private ones, use their own institutional methodology, which might count 529 assets differently. Luna: Can you give an example? Lucas: Sure. The CSS Profile, used by many expensive private schools, asks for all assets including 529 plans. But even then, they typically assess parental assets at a rate similar to FAFSA — around 5 to 6 percent. And some schools exclude 529 plans entirely or cap the assessment. The key takeaway: saving in a 529 plan is almost always better than saving in a regular taxable account or custodial account from a financial aid perspective. Luna: Let's tie that together with a concrete scenario. Say a family has fifty thousand dollars saved for college. How does the aid formula see it differently depending on where it sits? Lucas: Great question. Let's do the math. Fifty thousand in a parent-owned 529: assessed at 5.64 percent, so two thousand eight hundred and twenty dollars counted. Same amount in a student-owned custodial account: twenty percent, so ten thousand dollars counted. That's a difference of over seven thousand dollars in available assets per year, which could translate to a couple thousand dollars less in aid. Luna: That's significant. So the 529 plan essentially lets you keep more aid while still having the money. Lucas: Exactly. And with the Roth rollover option, you have an exit strategy if your child gets a full ride. It's one of the most flexible savings vehicles out there. Luna: So for parents worried about 'over-saving,' the Roth rollover and favorable aid treatment should ease that fear. Lucas: Yeah. It's not just about the tax benefits — it's about the strategic positioning for financial aid. And that's a message I think a lot of families miss. They either stash money in a regular brokerage account or they avoid saving at all because they're scared of the aid impact, when the 529 is actually designed to work with the system. Luna: Any final thoughts on what might change? Legislation always seems to tweak these rules. Lucas: The secure act changes are still pretty fresh. For now, the structure is stable. But I always tell families: focus on what you can control — contributing consistently, owning the account wisely, and not overthinking aid formulas. The aid landscape shifts, but the core advantage of a 529 is durable. Luna: Solid advice. That wraps it up for today. We'll be back with another angle on 529 planning next time.