How to Minimize the Impact of a Student's Brokerage Account on Financial Aid
November 26, 2012
However, contributions to a 529 college savings plan must be made with cash, not securities. So to roll a student’s brokerage account into a custodial 529 plan account, the parent must first liquidate the brokerage account. If the stocks, bonds or mutual funds held in the brokerage account have appreciated significantly, liquidating the account will result in capital gains. Capital gains are treated as income on the FAFSA. Student income received during the prior tax year will reduce need-based aid eligibility by as much as half of the amount of income. To prevent capital gains from affecting eligibility for need-based financial aid, realize them before January 1 of the junior year in high school.
Once the student is a senior in high school, however, there’s no room to liquidate the brokerage account without having the capital gains affect aid eligibility on the subsequent year’s FAFSA. It then becomes a tradeoff between the treatment of the capital gains as income and the treatment of the account as an asset. The student’s need-based financial aid package will be reduced by 20 percent of the asset value each year until the brokerage account is liquidated. If the money is rolled over into a custodial 529 plan account, the financial aid package will be reduced by up to 5.64 percent of the asset value each subsequent year until the money is spent. When the brokerage account is liquidated, the student’s need-based financial aid package during the subsequent year will be reduced by up to 50 percent of the capital gains.
Regardless of whether the money is spent on the student’s college education directly or rolled over into a custodial 529 plan account, the brokerage account must be liquidated. So realizing capital gains is unavoidable. (One could avoid liquidating the brokerage account until after the FAFSA is filed for the student’s senior year in college. But then the student’s asset will reduce aid eligibility by 20 percent of the asset value each year, or a cumulative total of 80 percent of the asset value. That is not a cost-effective solution.)
This suggests that the optimal strategy for a student who is already a high school senior is to liquidate the brokerage account immediately, spend as much as possible of the student’s money on the student’s education this year, and put the rest of the money in a custodial 529 plan account for subsequent years. The parent should not tap into any of the parent’s money until the student’s assets are spent down to zero.