529 Savings Plans, Trick or Treat?


College financial aid officers across the county have been in a state of euphoria ever since Congress made the 529 Plan tax exemption permanent. Adding to their joy is the increasing number of states making contributions to 529 accounts state tax deductible. Sadly, this will only encourage more unsuspecting families to set up these plans which will take most of them down a path paved with financial hazards. Ultimately, any family who opens one could be inviting devastating consequences when the financial aid process begins and withdrawals are taken.

Schools are likely to count their blessings for every needy student who has a 529. Such plans make it possible for the school to reduce financial aid awards dollar for dollar, thereby enriching their billion dollar endowment funds.

In the financial aid formulas, students have no asset protection allowance (APA). The sad result is, each year students lose 20 cents in financial aid for every dollar they have in cash, checking, savings, UGMA and/or UTMA accts., stocks, bonds, savings bonds, mutual funds, and the like.

Parents fare better as their assets are assessed at only 5.64% per year over their allowance. A two parent family for example, with an older parent of 48, has an APA of $33,000, while a single parent of 45, only has $7,100!

It gets even worse for families who are eligible for need-based financial aid. This money is deemed a resource and the financial aid department applies the asset assessment. Next, they reduce some of their own share of the student’s aid, dollar for dollar! The assessment is avoided when the owner of the account is not part of the family household, i.e. a grandparent, but the college’s aid is still reduced.

Unfortunately, tens of millions of dollars per year are unnecessarily wasted by college families who are unaware of the consequences when setting up 529 Savings Plans. In fact, numerous brokerage firms have been sued and/or suspended for misrepresenting the so-called benefits of 529 accounts.

Solution: Once a family becomes aware they will qualify for need-based financial aid, and that all of their 529 monies are at risk of being assessed, it is not too late and very easy to liquidate the account. The owner must contact the company managing their account and indicate they want a “non-qualified” (taxable) distribution. They will receive a redemption form and their check will follow shortly after the form is submitted.

Of course, liquidation is not without consequence either. All gains are subject not only to a 10% penalty tax, but also the applicable income tax based on the account owner’s tax bracket. Nonetheless, it is certainly the far lesser evil.

Example: A family who invested $40,000 and had a $10,000 gain would receive a check upon liquidation for $50,000. Assuming a 20% tax bracket, the $10,000 gain is subject to a $1,000 penalty tax, plus a $2,000 income tax. While many families have as much as $100,000 and more, the net result here is $47,000 that would avoid a maximum of $10,500 ($47,000 x 5.6% x 4) in assessments. If the money were legally repositioned into financial vehicles not included in the financial aid calculations, some or all of it would still be there at graduation time!

Here are two actual examples of what can be accomplished when assets are legally repositioned:

$15,252 Princeton University Tuition

$18,030 Financial Aid Received

$ 2,000 University of Tampa aid eligibility

$28,215 Aid increased after repositioning

When confronted with these facts, financial aid officers nationwide have sidestepped and smoke-screened the issue with comments such as, “Depending upon the value, there will be annual distributions to pay for tuition and fees,” or, “Our calculations may vary from year to year,” and this most disturbing remark originating from a prestigious New England school, “Financial aid is not the issue here. Paying for the student’s education is.”

Since the majority of American families can no longer afford four years of tuition and related expenses without financial aid, it most certainly is the issue! Camouflaging this fact is unconscionable, but par for the course when playing the game that today’s financial aid process has become.

The following illustrates exactly how 529 Savings Plans cause families to lose thousands in financial aid.

In a 2 parent family, let’s assume: an older parent of 44; 1 child, 17; AGI of $68,900; taxes paid $5,500; parent assets of $10,000; asset protection allowance of $30,000; student assets of $124:

Scenario A: $0 in a 529 Savings Plan

  1. Cost of Attendance: $ 45,000 (COA = tuition, fees, room & board, books and related expenses)

  2. Expected Family Contribution: $ 10,000 (EFC = the minimum the fed. gov’t. determines a family will pay at any school)

  3. Financial Need (FN) $45,000 – $10,000 = $35,000

    (FN = the maximum amount of need-based aid a family will qualify for)

  4. The student qualifies for the following aid:

(A) $ 5,500 Stafford Loan

(B) $ 2,000 Perkins Loan

(C) $ 2,500 Federal work-study award

(D) $ 3,000 State grants, etc.

(E) $ 2,000 Private scholarship

(F) $20,000 University scholarships, grants, tuition waivers, etc.

(G) $35,000 Total

The student will qualify for a maximum of $20,000/yr in financial aid from the college. However, the private scholarship will now become a bonus for the school, not the student. It enables them to reduce their aid dollar for dollar, because if (E) were $0, (F) would be $22,000.

Scenario B: $50,000 in a 529 Savings Plan

$45,000 COA less $11,000 EFC = $34,000 FN

  1. The student qualifies for the following aid:

(A) $ 5,500 Stafford Loan

(B) $ 2,000 Perkins Loan

(C) $ 2,500 Federal work-study award

(D) $ 3,000 State grants, etc.

(E) $21,000 University scholarships, grants, tuition waivers, etc.

(F) $34,000 Total

With $50,000 in the 529 Savings Plan, the family will most likely take a “qualified” distribution of $12,500/yr for 4 years; $11,000 of which, will pay their EFC. The school saves and the family will lose $1,500/yr in financial aid for 4 years. The school’s contribution (E), will now be reduced to $19,500

Scenario C: $100,000 in a 529 Savings Plan

  1. $45,000 COA less $12,800 EFC = $32,200 FN
  2. The student qualifies for the following aid:

(A) $ 5,500 Stafford Loan

(B) $ 2,000 Perkins Loan

(C) $ 2,500 Federal work-study award

(D) $ 3,000 State grants, etc.

(E) $19,200 University scholarships, grants, tuition waivers, etc.

(F) $32,200 Total

With $100,000 in the 529 Savings Plan, the family will most likely take a “qualified” distribution of $25,000/yr for 4 years; $12,800 to pay their EFC.

The school will save and the family will lose $12,200/yr in financial aid because $12,200 of the aid the college would have offered was replaced by the 529 distribution. The college’s contribution (E), will be reduced to $7,000.

If the money were in a financial vehicle not included in the financial aid calculations, the EFC would be reduced to $10,000 (Scenario A), and they would qualify for $22,000/yr for 4 years in financial aid.

Summary:

In the above Scenario C, a family with a modest EFC and a substantial 529 balance will lose the most. The break even point is when 529 annual distributions equal the EFC, and the account has a zero balance at the end of 4 years – an unlikely occurrence. There are a myriad of scenarios that can be played out here, but as always, it’s the “neediest” of families who lose the most.

Do not fall for the 529 trick this Halloween or any other time of the year. 529 Savings Plans for needy families must be avoided at all costs so they don’t become costly! In order to win the college funding game, which begins again every year, a family must have the most up to date information, precise timing and persistency. Also, families should never lose sight of the fact that all the financial aid in the world is useless without that coveted admission ticket!

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