Learn how a 529 plan affects your financial aid eligibility. Vanguard explains how account ownership and recent FAFSA changes affect your student's aid.
How does a 529 plan affect financial aid?
One of the most popular education savings account types in the U.S. is called a 529 savings plan. These plans help you save for education and offer tax benefits, high contribution limits, and flexibility.
This article explains the effect a 529 plan can have on the amount of financial aid a student is eligible to receive and what to keep in mind when withdrawing the money to minimize its impact on financial aid.
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What is financial aid and how is it calculated?
Financial aid is assistance that helps students pay for education expenses like tuition, books, and room and board. The process of applying for financial aid typically involves filling out the Free Application for Federal Student Aid (FAFSA).
Financial aid is calculated using a formula that factors in parental and student assets to determine the "expected family contribution" (EFC), which is the amount a family is expected to pay toward the cost of higher education.
Parental assets include savings, investments (other than retirement accounts and annuities), and real estate (other than the family's primary residence). The EFC generally considers about 5.64% of a parent's assets as available for educational expenses each year. For example, a $10,000 balance in a parent's savings account will increase the student's EFC by up to $564.
Student assets can include savings, scholarship money, and income from work or other sources, and investments (other than retirement accounts and annuities). The EFC typically considers about 20% of a student's assets as available for educational expenses each year.
Types of financial aid
Some types of college financial aid are based on need, while others are based on merit (like a music scholarship or community service grant).
- Grants are "free money" that you don't have to pay back. Need-based grants are available as part of a federal aid package. You can also apply for grants from private organizations.
- Scholarships also don't have to be paid back. They can cover multiple academic years, but students usually must meet specific criteria to keep the scholarship. (For example, a scholarship may be revoked if a student doesn't meet a required grade point average.) Scholarships could be part of a college's aid package, and you can also apply for scholarships from private organizations.
- Work-study programs provide employment through the college during the school year. A student could qualify for a work-study opportunity as part of a federal aid package.
- Need-based student loans for both parents and students are available through the federal aid program. Student loans are also available through private loan providers. Although they may seem like a great source of college money, unlike other types of financial aid, they must be repaid with interest.
How do 529s impact financial aid?
While a 529 plan is used for education expenses for the beneficiary (student), it may be owned by someone other than them. Typically another family member owns the account. How a 529 plan affects financial aid depends on the owner of the account. The following table shows the ownership types and their effect on financial aid:
| Ownership type | Effect on financial aid | Example |
|---|---|---|
| Parent-owned 529* | This is considered a parent asset on the FAFSA and can reduce aid eligibility by up to 5.64% of the account value. | A 529 plan account with $10,000 could reduce aid by $564. |
| Student-owned 529 | This is considered a student asset on the FAFSA and can reduce aid eligibility by up to 20% of the account value. | A 529 plan account with $10,000 could reduce aid by $2,000. |
| Grandparent- or relative-owned 529 | This isn't reported on the FAFSA. | A grandparent-owned 529 plan doesn't affect financial aid eligibility. |
*If a 529 plan is owned by a noncustodial parent and that parent doesn't file the FAFSA, the assets aren't reported and withdrawals won't affect a student's financial aid eligibility. It's treated the same way as a grandparent-owned 529 plan.
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Qualified vs. nonqualified 529 withdrawals
Withdrawals from 529 plans are categorized as either qualified or nonqualified depending on what the money is used for. If a withdrawal is qualified, it doesn't count as income. But nonqualified withdrawals could be considered income, which could affect financial aid calculations, tax treatment, and potential penalties.
Qualified 529 plan withdrawals are used to pay for eligible education expenses. They're tax-free at the federal level, and state taxes vary according to each state. There are no penalties associated with qualified withdrawals. Examples of qualified 529 plan withdrawals include those used for:
- Tuition and fees at eligible educational institutions.
- Room and board up to the cost of a dorm, or the cost of off-campus housing if it's reasonable.
- Books and supplies required for enrollment or attendance.
- Equipment needed for coursework, including computers and internet access.
- Special needs services for students who need them.
Nonqualified 529 plan withdrawals are used for expenses other than eligible education expenses. Noneducational expenses include things like buying a car or paying off credit card debt.
If you take a nonqualified 529 plan withdrawal, the principal amount isn't taxed. However, the earnings portion of the withdrawal is subject to federal income tax and a 10% tax penalty. In some states, the earnings portion may also be subject to state income taxes and penalties, and you could lose any state tax benefits you previously claimed.1
The impact of 529 plan earnings on financial aid
Contributions made to a 529 plan are made with after-tax dollars at the federal level. One of the key benefits of a 529 plan is tax-free growth, which can significantly enhance the value of the savings over time. When determining the 529 impact on financial aid, the earnings aren't directly reported on the FAFSA.
Tax-free growth helps set 529 plans apart from taxable savings accounts since the contributions can grow each year they're in the account without being taxed. If the money is then used for qualified education expenses, it can be withdrawn tax-free.
Does a grandparent-owned 529 plan affect financial aid?
The rules regarding grandparent-owned 529 plans and their effect on financial aid have recently changed, beginning with the 2024–2025 FAFSA.
Old rule vs. new rule
Before the 2024–2025 FAFSA update, neither the balance nor any withdrawals of a grandparent-owned 529 plan were reported as an asset on the FAFSA. However, any withdrawals were considered untaxed income for the student in the following year's FAFSA. Withdrawals assessed as untaxed income were assessed at a rate of up to 50%, which could significantly affect the student's financial aid eligibility.
Starting in the 2024–2025 academic year, the simplified FAFSA no longer requires withdrawals from a grandparent-owned 529 to be reported.
Strategies to minimize aid reduction due to a 529 plan
To help maximize the amount of aid a student receives, consider the ownership of the account when withdrawing from it. If a student has a grandparent- or parent-owned 529 plan, it may be best to withdraw from those before a student-owned account.
To avoid any negative tax impact, make sure that the money is used for qualified expenses like room and board, books, and supplies.
If you have questions, consult with the school's financial aid office to get advice about your situation.
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No. Withdrawals from 529 plans generally do not count as student income as long as they're used to pay for qualified education expenses.
A 529 plan can potentially affect Pell Grant eligibility. The ownership type of the 529 plan determines how it affects Pell Grant eligibility. A grandparent-owned 529 plan will not reduce Pell Grant eligibility. A parent-owned 529 plan will reduce it by 5.64%. And a student-owned 529 plan will reduce it by 20%.
No, if a 529 plan is owned by a noncustodial parent and that parent doesn't file the FAFSA, the assets aren't reported and withdrawals won't affect a student's financial aid eligibility. It's treated the same way as a grandparent-owned 529 plan.