Confusion about Reporting Custodial 529 College Savings Plan Accounts on the FAFSA - Fastweb

Confusion about Reporting Custodial 529 College Savings Plan Accounts on the FAFSA

By The Fastweb Team

September 26, 2017

Confusion about Reporting Custodial 529 College Savings Plan Accounts on the FAFSA

My daughter is a freshman (in college) and lives more than 50% of the time with her mother who is the custodial parent. Her mom and I have been divorced for the last 10 years. I personally had an UGMA account set up for my daughter years ago. But two years ago I converted my daughter’s $25,000 UGMA account to a Custodial 529 plan account. Is my daughter required to report this 529 on the FAFSA as her ‘asset’? I do not think she included this custodial 529 plan account on the FAFSA for her freshman year in college. As I recall, the FAFSA does not seem to request 529’s specifically by name, so that’s why I am wondering. Any help is greatly appreciated. — Kevin M.

A 529 college savings plan account that is owned by the student or the student’s parent must be reported as an investment asset on the Free Application for Federal Student Aid (FAFSA). Distributions from such a 529 plan are not reported as income on the FAFSA. As noted in How Do Grandparent-Owned 529 College Savings Plans Affect Financial Aid Eligibility, other 529 plans are not reported as assets on the student’s FAFSA, but distributions from such 529 plans are reported as untaxed income to the student on the subsequent year’s FAFSA.

While the form itself does not have a line specifically for 529 plans, the instructions clearly indicate that 529 plans must be reported in one of the lines for investments:

“Investments also include qualified educational benefits or education savings accounts (e.g., Coverdell savings accounts, 529 college savings plans and the refund value of 529 prepaid tuition plans). For a student who does not report parental information, the accounts owned by the student (and/or the student’s spouse) are reported as student investments in question 41. For a student who must report parental information, the accounts are reported as parental investments in question 89, including all accounts owned by the student and all accounts owned by the parents for any member of the household.”

Families sometimes get confused about the difference between a 529 plan’s owner, beneficiary and custodian. Every 529 college savings plan account has an account owner and a beneficiary. The owner has control over the account and can change the beneficiary. The beneficiary is the student who will receive the funds from the account to pay for college costs.

Usually the parent is the account owner and the student is the beneficiary. Sometimes, however, the student is both the account owner and beneficiary. This can occur when the money invested in the 529 plan account came from an UGMA or UTMA bank or brokerage account. Since minor children cannot legally own assets, the money is invested in the custodial version of a 529 plan account where a custodian (often a parent) acts on behalf of the child until the child reaches the age of majority. The custodial 529 plan account is titled the same way as the UGMA or UTMA account it replaced. Even though the custodian can control the account on behalf of the child, the child is considered the account owner, not the custodian. The custodian cannot change the beneficiary on a custodial 529 plan account.

So normally a student who owns a 529 college savings plan will report the plan’s value as a student investment on the student’s FAFSA. This is the case for independent students. But the College Cost Reduction and Access Act of 2007 changed the treatment of custodial 529 plan accounts owned by a dependent student, starting with the 2009-10 award year. When a dependent student owns a 529 plan, the 529 plan is treated as though it were a parent asset on the student’s FAFSA. This yields a more favorable treatment, since student assets are assessed more heavily than parent assets. (Note that a student is considered dependent or independent for federal student aid purposes according to criteria established by the Higher Education Act of 1965. This is not necessarily the same as a student who is considered dependent for federal income tax purposes, which is based on the Internal Revenue Code of 1986.)

When the student’s parents are divorced, only one of them is responsible for completing the FAFSA. This parent is the one with whom the student lived the most during the 12 months ending on the FAFSA application date (or failing that, the parent who provided the most support). This parent is referred to as the custodial parent, and the other parent as the non-custodial parent. Only the custodial parent’s income and assets (plus the step-parent’s income and assets, if the custodial parent has remarried) must be reported on the student’s FAFSA. The non-custodial parent’s income and assets are ignored.

(The word “custodial” has different meanings when referring to a 529 plan account and to the parent responsible for completing the FAFSA, adding to the potential for confusion.)

It does not matter whether the custodian on a custodial 529 plan account is the custodial parent or the non-custodial parent. With a custodial 529 plan, the custodian is a placeholder for the student, not the account owner. The custodial 529 plan account is owned by the student, and if the student is a dependent student, treated as an asset of the parent who completes the FAFSA.

This is in contrast with a scenario in which the non-custodial parent is the owner of a 529 college savings plan account and not just the custodian on a custodial 529 college savings plan account. When the non-custodial parent owns a 529 plan, that 529 plan is not reported as an asset on the student’s FAFSA, but any distributions from such a 529 plan are reported as untaxed income to the student. This can have a severe negative impact on the student’s eligibility for need-based aid. There are two effective workarounds. One involves changing the account owner from the non-custodial parent to the custodial parent. The other involves waiting until the student’s senior year in college to take a distribution from the 529 plan account, when there will be no subsequent year’s FAFSA to be affected.

To summarize:

  • If the custodial parent owns a 529 plan account, it is reported as a parent investment asset on the student’s FAFSA and distributions from this 529 plan account are ignored. This is regardless of whether the student or someone else is the beneficiary.

  • If the non-custodial parent owns a 529 plan account with the student as the beneficiary, it is not reported as an investment asset on the student’s FAFSA, but any distributions are reported as untaxed income to the student on the subsequent year’s FAFSA.

  • If a dependent student owns a custodial 529 plan account, it is reported as though it were the custodial parent’s asset on the student’s FAFSA, regardless of whether the custodial parent or the non-custodial parent is the custodian on the custodial 529 plan account.

  • If an independent student owns a custodial 529 plan account, it is reported as a student investment asset on the student’s FAFSA.

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