Parents can start saving for their children’s college education at any time, with the help of a 529 Plan. It’s essentially a savings account that can be created by parents and grandparents, and disbursed to the student when they enter college, to be expressly used for tuition and associated academic expenses. This investment vehicle has tax implications, meaning it should be researched thoroughly and consulted on professionally, in order to avoid any infractions and associated penalties.
529 Plans, also known as Qualified Tuition Plans, are savings plans that have tax advantages. Named after Section 529 of the Internal Revenue Code, these plans are designed for families to save for their little ones’ education over a long period of time. Down the road, the funds can be used for K-12 tuition, college tuition, and even student loan payments.
It’s very import to understand that funds within the 529 Plan can only be used for qualified educational expenses – exactly what expenses are considered “qualified” can be found within Section 529 of the IRS website. If the funds are used for “unqualified” expenses, or expenses that are outside of what’s approved, they will be taxed heavily including a 10% withdrawal penalty.
529 plan distributions, or withdrawals, are treated very favorably with regard to taxes. If funds are withdrawn from the student or parent 529 plan for current year educational expenses that are qualified, the funds are not considered “base year income”, which (if they were) could dramatically reduce the amount of financial aid available to the student. Essentially, if student or parent funds are used appropriately for approved educational expenses, they will have little to no impact on how much financial aid is disbursed from the FAFSA form.
Unfortunately, the outcome changes if funds are withdrawn from a grandparent’s (or anyone else’s) 529 plan. When a grandparent or someone else withdraws funds from their 529 plan to pay for a student’s qualified educational expense, the money is counted as income on the FAFSA form. It will be assessed at 50%, meaning a $10,000 payment will reduce the student’s financial aid amount by 50%, or $5,000. A common way to get around this, is to start paying towards the student after they start their junior year of college, since FAFSA only looks back at the last 2 years. While this information is common knowledge, it’s best to consult a tax or FAFSA professional before making a decision.