How Do Grandparent-Owned 529 College Savings Plans Affect Financial Aid Eligibility?
Rules for Treatment of 529 College Savings Plans as Income and Assets
By The Fastweb Team
August 31, 2017
Correct Treatment of 529 Plans as Income and Assets
The College Cost Reduction and Access Act of 2007 (CCRAA) (P.L. 110-84) amended subsection 480(a)(2) of the Higher Education Act of 1965 to change the treatment of 529 plans on the FAFSA, effective July 1, 2009. The statutory language as amended by the CCRAA reads as follows:
and no distribution from any qualified education benefit described in subsection (f)(3) that is not subject to Federal income tax, shall be included as income or assets in the computation of expected family contribution for any program funded in whole or in part under this chapter
This section of the Higher Education Act of 1965 is often misinterpreted as indicating that all distributions from 529 plans are ignored on the FAFSA. However, the language “described in subsection (f)(3)” is important because it limits the scope of the 529 plans for which distributions are excluded from income to just those plans described in subsection 480(f)(3) of the Higher Education Act of 1965. Distributions from plans that are not described in subsection 480(f)(3) may still be counted as income on the FAFSA.
Subsection 480(f)(3) of the Higher Education Act of 1965 reads as follows:
A qualified education benefit shall be considered an asset of —
(A) the student if the student is an independent student; or
(B) the parent if the student is a dependent student, regardless of whether the owner of the account is the student or the parent.
Subsection 480(f)(3) describes the 529 plans that are reported as assets on the FAFSA as including only plans that are owned by the student or parent. Grandparent-owned 529 plans (and all other 529 plans owned by someone other than the student or parent) are not reported as assets on the FAFSA because they do not fall within the scope of subsection 480(f)(3).
But it is also precisely because such 529 plans do not fall within the scope of subsection 480(f)(3) that distributions from such 529 plans count as untaxed income on the subsequent year’s FAFSA. The reference to subsection 480(f)(3) in subsection 480(a)(2) restricts the exclusion of 529 plan distributions from income on the FAFSA to just the 529 plans described by subsection 480(f)(3), namely the 529 plans that are reported as an asset on the FAFSA.
Thus, if a 529 plan is not reported as an asset on the FAFSA, distributions from the 529 plan count as untaxed income to the beneficiary on the subsequent year’s FAFSA. The treatment of a 529 plan as an asset cannot be separated from treatment of distributions as income. The two are inextricably linked.
For example, distributions from a grandparent-owned 529 plan are counted as untaxed income to the beneficiary on the subsequent year’s FAFSA because the grandparent-owned 529 plan is not reported as an asset on the FAFSA.
A similar treatment also applies to other qualified education benefits, such as prepaid tuition plans and Coverdell education savings accounts.
Note that if a student’s parents are divorced, the income and assets of the non-custodial parent are not reported on the student’s FAFSA. In particular, if the student’s 529 plan is owned by the non-custodial parent, the 529 plan is not reported as an asset on the FAFSA, but any distributions from the 529 plan count as untaxed income to the student on the subsequent year’s FAFSA.
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