Hi Terry, it was good to see your article discussing the FAFSA today. My daughter is a freshman at a state university so this is my second year filing the FAFSA. I am remarried so my second husband’s income is counted on the form. However, her dad (non-custodial parent) has a 529 plan that he owns with her as the beneficiary. My original plan had been to use those funds in her senior year since the withdrawals will count heavily as untaxed income. However, recently we have talked about changing the ownership of the 529 to my name since then it will count up front as an asset on the FAFSA and then the withdrawals will not count for her and we can start using them sooner. First, is that correct? It seems too easy. Second, since I am age 55, I have a pretty large allowance for protected assets on the FAFSA. Even with the 529, my assets would be less than $36,000. If the 529 value is within the protected assets and will not even appear on the FAFSA, will that change how it is valued when my daughter takes the withdrawals? I should probably also let you know that last year our EFC was less than $7,000 so I am trying not to jeopardize that figure. Lastly, if it is beneficial to change the 529 ownership, should we do that this year before I file the FAFSA? If we wait until after, will we have to wait a year to use it without penalty? Thank you for your help.
Terry Says: Your question was so complicated that I went straight to the expert — Mark Kantrowitz, founder of Finaid.org and now edvisors.com. He knows everything about financial aid. I decided to cut and paste his response in full below:
If a 529 plan is owned by the non-custodial parent, it is treated the same as a grandparent-owned 529 plan. It is not reported as an asset on the FAFSA, but any distributions are counted as untaxed income to the student on the subsequent year’s FAFSA. This reduces aid eligibility by as much as half of the distribution amount.
In contrast, if a 529 plan is owned by a dependent student’s custodial parent, it is reported as an asset on the FAFSA and distributions are ignored. Reporting it as an asset reduces aid eligibility by at most 5.64% of the net asset value. (Depending on the amount of parent assets, the value of the 529 plan might not have any impact on the EFC. There is an asset protection allowance based on the age of the older parent which shelters about $30,000 to $60,000 in assets, which may cover all or part of the 529 plan account, depending on the amount in the 529 plan and the amount of other assets.)
There are two main workarounds for a 529 plan that is owned by the non-custodial parent. One is to wait until the senior year in college to take a distribution, when there is no subsequent year’s FAFSA to be affected (assuming that the student is not going on to graduate school). The other is to change the account owner from non-custodial parent to custodial parent.
Whether one can change the account owner depends on the state. Some state plans allow it, some do not. If the beneficiary will not be changing, there generally won’t be gift tax implications, but it is best to check with an accountant.
It is best to time the change of account owner to occur after the FAFSA is filed (so that the 529 plan won’t be counted as an asset) but before taking a distribution (so that the distribution will not count as untaxed income to the beneficiary on the subsequent year’s FAFSA).
Note that the 529 plan, after the account owner is changed to the custodial parent, must be reported on the FAFSA, contrary to what the parent wrote. It’s just that the federal financial aid formula will subtract the asset protection allowance from total parent assets (including the 529 plan account) before assessing the remaining reportable assets on a bracketed scale that tops out at 5.64%. She’s got the right idea, but is a bit off on the details of how it works. Since the 529 plan is reported on the FAFSA, even if all or part of it is sheltered by the asset protection allowance, any qualified distributions will be ignored on the subsequent year’s FAFSA.
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