Gauging the impact of 529 plans on financial aid

Q: The personal-finance press is awash in stories about 529 plans, which seem to be emerging as the pre-eminent college-savings tool. But I can't get a handle on the plans' impact on financial-aid prospects. When the money is withdrawn tax-free for college expenses, is it considered part of the student's assets, or part of the parents' assets – and which of those is the bigger factor in determining financial-aid need?
M.E., Boston

A: We checked with several sources on this question, which is being asked by many parents with prospective college-bound students. The answer, says New York-based financial planner Gary Schatsky, is that "colleges are not consistent in how they treat 529 plans for financial aid."

While state colleges tend to be fairly consistent, private colleges are far less so. Many private colleges, for example, do not follow standard methods to compute the "expected family contribution" (EFC) – the amount a family would be likely to put toward a student's school costs.

What is clear, financial experts agree, is that ownership of a 529 plan increases the difficulty of receiving financial aid. Whether the tax savings is worth the trade-off is a function of the plan holder's income-tax bracket and total assets.

Still, a 529 plan owned by a parent will trigger less of a hit on aid propects than if the plan is owned by the child, Mr. Schatsky says. Usually, when someone opens a 529, a child is listed as a beneficiary. But 529s can be opened without naming a beneficiary. Also, a new beneficiary can be named before withdrawal.

Once money from a 529 is given to the child, it is considered the child's asset for purposes of computing possible aid. When a child owns the savings plan, says Schatsky, "there is almost a guaranteed dollar-for-dollar reduction in aid." But a 529 plan owned by an adult usually gives one "a lesser reduction in aid at most colleges," he says. So the worst step would be to open a custodial account in the name of the child, Schatsky says.

Rich Chambers, a financial planner in Palo Alto, Calif., suggests that grandparents – whose assets usually aren't used to determine the EFC – own 529s.

Both Chambers and Schatsky endorse 529s but caution that the rules surrounding them may change. For more information, see www.smartnewchoice.com, or "The Best Way to Save For College: A Complete Guide to 529 Plans," by Joseph F. Hurley (Bonacom Publications, $26.95.)