How Does a 529 Plan Affect Your FAFSA?

The Free Application for Federal Student Aid (FAFSA) and 529 college savings plans are two significant components of higher education financing. Understanding their interaction is important for effective financial planning for college expenses.

Key FAFSA Concepts and 529 Plan Overview

The FAFSA serves as the primary application for students seeking federal financial aid, including grants, scholarships, work-study programs, and federal student loans. It gathers financial and demographic information to calculate the Student Aid Index (SAI). The SAI, which replaced the Expected Family Contribution (EFC) starting with the 2024-2025 award year, is an eligibility index number that helps colleges and financial aid offices determine a student’s need for financial assistance. A lower SAI generally indicates a greater financial need, potentially leading to more aid.

A 529 college savings plan is a tax-advantaged investment vehicle designed to help families save for future education costs. Funds within a 529 plan grow tax-deferred. Qualified withdrawals used for eligible educational expenses, such as tuition, fees, and room and board, are entirely tax-free at the federal level.

Reporting 529 Plan Assets on FAFSA

The treatment of 529 plan balances on the FAFSA depends on who owns the account. Funds held in 529 plans owned by a dependent student or one of their parents are considered parental assets. Parental assets are assessed at a lower rate, up to 5.64% of their value, when determining the SAI. This means that for every $10,000 in parental 529 assets, approximately $564 or less might be considered available for college expenses.

If a 529 plan is owned directly by the student, which is less common for dependent students, it is reported as a student asset. Student assets are assessed at a higher rate, up to 20% of their value. This higher assessment rate means that student-owned assets can have a greater impact on financial aid eligibility compared to parent-owned assets.

529 plans owned by grandparents or other non-parent relatives are not reported as an asset on the FAFSA. This exclusion from the asset calculation can be an advantage for families receiving support from non-parent sources.

Impact of 529 Plan Distributions on FAFSA

How 529 plan distributions affect FAFSA calculations depends on the account owner and the nature of the withdrawal. Qualified distributions from parent-owned or student-owned 529 plans, used for eligible educational expenses, are not counted as income on the FAFSA. This allows families to use their savings without negatively impacting financial aid eligibility through an income assessment.

Non-qualified distributions from a 529 plan—money used for purposes other than eligible educational expenses—are considered taxable income to the recipient. If a non-qualified distribution is received by the student, it is reported on the FAFSA as untaxed income, which could potentially reduce aid eligibility in subsequent years.

The FAFSA Simplification Act, effective for the 2024-2025 academic year, concerns distributions from grandparent-owned 529 plans. Previously, these distributions were counted as untaxed student income on the FAFSA, which could significantly reduce a student’s eligibility for need-based aid. Under the new rules, distributions from 529 plans owned by grandparents or other non-parents are no longer counted as income on the FAFSA. This change eliminates a former disincentive for grandparent contributions and allows their support to be used without impacting federal financial aid.

Timing and Ownership Considerations for 529 Accounts

The FAFSA uses a “prior-prior year” approach for income reporting, meaning it considers income from two years prior to the academic year for which aid is sought. For example, the 2025-2026 FAFSA would use 2023 income information. Assets are reported as of the date the FAFSA is filed. This distinction is important for financial planning.

Contributions made to a 529 plan before the FAFSA filing date are included in the asset calculation. If a family plans to contribute a large sum to a 529, doing so well in advance of the FAFSA submission provides time for any market fluctuations to occur before the asset snapshot date.

Qualified withdrawals from parent-owned or student-owned 529 plans do not impact the FAFSA as income, regardless of when they occur. For grandparent-owned 529s, the FAFSA Simplification Act’s change means that distributions are no longer counted as income, making the timing of these withdrawals less impactful on federal aid eligibility from an income perspective.

Transferring ownership of a 529 account, for instance, from a grandparent to a parent, before the FAFSA is submitted, causes the asset to be reported as a parental asset. This could be a consideration as parental assets are assessed at a lower rate than student assets. The FAFSA rules consider the account’s ownership status at the time of filing.