Grandparent Ownership of Assets
If a 529 college savings plan, prepaid tuition plan or Coverdell Education Savings Account is owned by a grandparent, it is not reported as an asset on the FAFSA. Similarly, if the student's parents are divorced and one of these qualified tuition program accounts is owned by the noncustodial parent, it is not reported as an asset on the FAFSA.
This is in contrast with the treatment by the CSS/Financial Aid PROFILE form, which requires any 529 plan that lists the student as the beneficiary to be reported.
However, excluding these accounts as assets does not yield an improvement in eligibility for need-based financial aid. Guidance published by the US Department of Education requires distributions from these accounts to be treated as untaxed income to the student. Since a student's total income is assessed at a rate of 50% above a small income protection allowance, this can have a severe negative impact on the student's eligibility for need-based financial aid the next year. In fact, this is much worse than if the account were reported as a parent asset on the FAFSA.
What if there are multiple children, each with a 529 plan owned by a grandparent? Wouldn't that yield a better outcome? After all, if the 529 plans were owned by the parents, they would all be reported on the FAFSA for each child, reducing aid eligibility, while grandparent-owned 529 plans only affect aid eligibility when a distribution is taken. But the impact of the grandparent-owned 529 plans is so much greater that the parents would have to have at least 8 children for the grandparent ownership option to have less of an overall financial impact.
One possible solution is to change the account owner to the student or the student's parents. Another possible solution is to wait until the student's senior year in college to take a distribution since it does not affect aid eligibility for the current award year, only for the subsequent award year. (It is important to take the distribution after the FAFSA has been filed for the year.) Or one could wait until after the student has graduated to take a nonqualified distribution; the income tax and tax penalty on a nonqualified distribution are not as severe as the loss of need-based aid eligibility from treating the distribution as untaxed income to the student.
See Section 529 College Savings Plan Loophole for additional discussion.
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