It’s
that time of year again—students are moving into the dorms at colleges and
universities all over the country. Traffic is increasing, restaurants are
crowded, and all the other “problems” associated with students starting a new
school year are at the forefront. It’s a new world for freshmen students;
confusing and sometimes stressful. That stress is not limited to students,
however. Parents are looking at rising education costs and looking for ways to
pay for college expense. A frequent source of that funding comes from college
savings accounts (such as 529 plans) and from extended family (grandparents).
Those sources are our topic of discussion here.
The
529 college savings plans are sponsored by states and the funds in those plans
are managed by large mutual fund companies (Vanguard, Fidelity, American Funds,
etc.). After tax contributions placed into the accounts grow tax free as long
as the funds withdrawn are used to pay for qualified college expenses (room,
board, tuition, mandatory fees, books and equipment, etc.). Historically,
parents have been the ones setting up 529 plans for children; the owner of the
account is the person setting up the plan. However, with rising college costs
and more affluence in the retiring baby boom generation, grandparents are
funding 529 plans. That’s a great benefit for easing the financial burden on
parents of college students. It can come with some hidden implications that
should be addressed.
College
personnel award financial aid to students based on the income and assets that
students and their parents claim on the students Free Application for Federal
Student Aid (FAFSA) form. Contributions from parents are not counted as student
income for FAFSA purposes. That is true even when the funds come from a 529
plan owned by the parent. However, when funds come from other people (such as
529 plans owned by grandparents), the funds are counted as student income.
Therefore, payments from a grandparent owned 529 plans could jeopardize the
student’s eligibility for other forms of financial aid. Limitations (or loss)
of grants, subsidized federal loans (on which the student is not charged
interest while still in school), or work study programs funded by the
government or college might come into play. The loss of such benefits could be
significant. Prudent planning dictates consideration of such a loss in the
total cost of a student’s education.
Are
there ways for grandparents to fund college expenses and still get the tax free
growth on the funds? Perhaps. The grandparents could possibly transfer
ownership of the 529 plan to the parents prior to any withdrawal for college
expenses. Some plans don’t allow a transfer of ownership and may count the
transfer as a distribution (earnings are then subject to taxes and a penalty
because the distribution was not used for allowable college expense). Another
possible alternative would be to wait until the student’s last year in school
before using 529 funds. The student (not attending graduate school) would not
be filing another FAFSA for the following year; hence no income considerations.
Care should be taken here though as some colleges require additional
information that requires listing all accounts benefiting the student which are
owned by other than the parents.
While
students are facing the academic world (many for the first time), planning for
college expenses should be done in advance. We, at Paragon Financial Advisors,
will be happy to review the plans our clients have put in place. Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.
