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 After tax contributions placed into the accounts grow tax free as long as the funds withdrawn are used to pay for qualified college expenses (room, board, tuition, mandatory fees, books and equipment, etc.).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.

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