529 Questions-advice needed

<p>I read in the NY Times blog The Choice that a distribution from a grandparents' 529 gets counted as untaxed income to the student for the next year financial aid application and that it has a serious effect on aid eligibility? Can anyone tell me about their experiences with this? What is the best thing to do about this? Use it only for paying back loans ( if that is allowed?) or is this not something to worry about? Should/can the account ownership be transferred?
My second question has to do with the parent's 529. If there is enough in it to pay for one year of the EFC is it best to use it all the first year or spread it out?</p>

<p>It’s true that distributions from grandparent-owned 529s are reported as student untaxed income on the following year’s FAFSA. Students have an income allowance of $6000, so if the distribution is less than that it will have no effect on your EFC. Many people here will tell you to have the distributions made after the last FAFSA is filed (January/February of the student’s junior year) so that it won’t need to be reported. Money in 529s can only be used to pay expenses in the current calendar year. The account ownership can be transferred, but that doesn’t buy you anything. Say it’s transferred to an aunt; any distributions to the student would still need to be reported. Or do you mean can the account beneficiary be changed? Yes, but the money isn’t reported as an asset in the first place, it’s reported as income.</p>

<p>A parent-owned 529 has relatively little effect on EFC, at most 5.6%. It just depends on your own financial situation if you want to spend it all in year 1 or spread it out. For my sons who each have a 529, I spread it out over all 4 years.</p>

<p>If you change account ownership to the student or parents it will then be counted as a parental asset, but the distribution won’t be income. However, you need to be careful to make the transfer before the base year (so well before you’re ready to file the FAFSA. For a current Senior applying to colleges, it should have been transferred before January of 2012. Remember also that if is is a significant amount, it could also trigger the need to file a gift tax return for the original account owner (though it’s unlikely any gift tax would be due).</p>

<p>Otherwise, speak to your financial aid office. One thing I like about our D’s first choice is their affordability policy. Barring major changes (like a multi-million dollar lottery win), the aid package they offer is usually a 4-year offer. That means we can spend down the grandparents’ 529 accounts toward first year tuition, rather than waiting until senior year, when it no longer matters if it’s untaxable income (and later if going straight to grad school, because it is income to the STUDENT, not the parents, so would still show up on an independent student’s FAFSA).</p>

<p>I didn’t consider the transfer to the parent, but yes, that’s always a possibility and does avoid the nontax income issue as CTScoutmom notes. It can be done at any point prior to filing FAFSA, even if it’s in the base year, as it’s not income to the parent and doesn’t need to be reported as such.</p>

<p>You can also transfer ownership to the account beneficiary (the student) which avoids a potential gift tax issue. Although there is nothing that currently says the change of ownership is to be treated as a gift from the account owner to the new owner, the IRS has proposed new rules that could in the future have that effect.</p>

<p>Different 529 plans have different rules for changing ownership. For example, Fidelity will generally treat an owner change as a reportable distribution, which you want to avoid. And New York’s 529 plan does not permit owner changes at all. An option would be to first roll over to a different plan without these restrictions.</p>

<p>Transfer to the beneficiary wouldn’t cause a gift tax issue, because it is already a gift to the beneficiary when the contribution is made. However, tranferring to the parents could be a problem (and probably would end up being reportable as non-taxable income), because few 529 plans allow for transfer of ownership, except as part of an estate.</p>

<p>IRS guildelines specifically state (in pub 970) that change of beneficiary doesn’t have tax consequences as long as it is to a family member of the current beneficiary, and does allow rollover to an account with the same beneficiary or a family member, but 970 doesn’t actually address the issue of account ownership.</p>

<p>Again, because most plans don’t allow for transfer of ownership, such a change would generally be considered a distribution - and that could trigger tax on earnings, penalties, and possible recapture of and state tax benefits. And then it would also be a gift to the new account owners, and reportable on the FAFSA. Further, since the IRS has offered no guidance on change of account ownership, it may be considered non-taxable income to the parents if transferred to them. The best way to avoid any possible issue is to transfer before the base year.</p>

<p>Most plans actually do allow a change of ownership:</p>

<p>[Compare</a> 529 Plans](<a href=“Compare 529 Plans - Saving for College”>Compare 529 Plans - Saving for College)</p>

<p>Not sure that a 529 Plan vendor allowing an ownership change is the same as the IRS allowing an ownership change (i.e. a change in asset ownership not subject to gift tax rules)…</p>

<p>Thanks for all the input. So if the grandparent gives $5K a year from a 529 then it sounds like it will not affect EFC ? Why do people say to wait until junior year- is that for people that would take more than the $6K?
This is from that NY Times blog:“Untaxed income to the student has a big impact on aid eligibility, much more severe than a parent asset. There are several ways of addressing this problem. One is to wait until the student’s senior year in college to take a distribution. Assuming the student won’t be continuing on with graduate or professional school, there will be no subsequent year in school to be affected by the distribution. Otherwise the grandparent could change the account owner to the student or parent so that it will be reported as an asset on the Fafsa.” The last sentence was why I asked about transferring ownership. But since the distribution would be less than 6K then it sounds like we don’t need to worry? Anyway we are in NY and transfer is not an option then…</p>

<p>It’s not just an issue of more than $6000, but of more than $6000 when included with other income. If used after Junior year, assuming the student isn’t going on to grad school, there would not be a subsequent FAFSA on which it would be reported. Since you’re talking about a specific student - will the student have other income for the year? If not, then go ahead and use the grandparents’ 529. </p>

<p>As for the parent 529, it doesn’t really make much difference when it is used, unless the other option is to take loans. It is a parental asset, and if you use it, presumably you will save the money you don’t have to use elsewhere - in the end you still have an asset either in the form of a 529 or in some other form. The advantage to spreading out the 529 distribution is the tax advantage on any earnings (though it isn’t going to be very much). If you use the 529, any earnings on the money you “saved” will still be taxable.</p>

<p>I would use it over taking loans, unless part of a plan involving grad school, where you want to make use of the maximum loans over the entire education. I would not use it over the student’s earnings, since those are assessed at a higher rate.</p>