Posted by Lee Sausen
According to Collegeboard.org, the average yearly college tuition rates in 2015 for public colleges (in-state), public colleges (out-of-state), and private colleges, are $8,655, $21,706, and $29,056, respectively. Compare those figures to the University of Delaware’s 2014-2015 tuition rates of $12,342 in-state and $30,692 out-of-state. With tuition rates in the U.S. doing everything but falling, you might find yourself wondering how you will support your child through those four (or more) important years. To learn the basics of the Free Application for Federal Student Aid (FAFSA), Section 529 College Savings plans, and how they work together, read on.
The Federal Student Aid Office takes into account a few different factors when evaluating your application (the FAFSA) for financial aid. These factors (described below) are entered into a formula to arrive at your Expected Family Contribution (EFC). The higher your EFC, the less federal aid you will receive, and vice versa. Please keep in mind that school-based aid formulas are not always the same as the federal formula. Income on this year’s tax return (2014, for example) will be reported on next year’s application (for school year 2015-2016). Each of the following amounts will be input on the application and assessed at a different rate to determine your EFC:
- Parent’s Non-retirement Investment Assets – maximum of 5.64%
- Parent’s Available Income (includes income that is taxable by the IRS, untaxable by the IRS, and benefits – such as Social Security & Unemployment – less certain allowances) – roughly 15-20% depending on state of residency and other factors
- Student’s Non-retirement Investment Assets – 20%
- Student’s Available Income (income defined by FAFSA less certain allowances) – 50%
For example, if the student had $10,000 of available income during calendar year 2014, the EFC for the 2015-2016 school year would be increased by $5,000 (50% of 10,000). Family size and number of family members attending college are also considered when determining eligibility. If a family’s Adjusted Gross Income (from form 1040) is under $50,000, then their assets will not be included in determining their EFC.
Internal Revenue Code Section 529 College Savings Plans (sometimes called Qualified Tuition Programs) are investment vehicles with significant tax advantages for both future college students and for family members who plan on helping those students fund part of the expense associated with going to college. Earnings on an investment in a 529 plan grow income tax-free. Any withdrawals from a 529 plan are income tax-free if they are put towards post-secondary education expenses such as tuition, required fees, books, and certain room and board, equipment, and supplies’ costs. However, if a distribution (withdrawal) is spent on a non-qualifying expense, the money will be subject to federal taxation in addition to a 10% penalty.
It is true that an investment in a 529 plan will increase your EFC, but the same dollar amount in some other investment vehicle could increase your EFC by even more. An investment in a 529 plan is considered the parent’s assets for purposes of the FAFSA regardless of whose name the plan is under (parent’s name or child’s name). This is a big advantage over a mutual fund, for example, which if in the student’s name, would boost the EFC by 20% of the investment (student’s rate) vs 5.64% (parent’s rate).
What about a grandparent’s 529 plan? Good news – the FAFSA does not take into account the assets of a grandparent or other relatives. However, the form does ask for the student’s available income, which would include any amount provided by someone other than a parent. Considering that the rate on the student’s available income is the highest for determining the EFC (50%), grandparents should be careful with the timing of their distributions. Waiting until after the last FAFSA has been submitted (during the student’s junior year of college) might be best. Remember – if the distribution is spent on qualified education expenses, the earnings will still be excludable from income on the plan holder’s tax return.
Another advantage of 529 plans is that distributions taken by the parent will be excluded from income on the FAFSA. This is not true for withdrawals from mutual funds – that type of distribution is both taxable and reportable on the FAFSA.
If you are applying for financial aid for the 2015–2016 school year, the federal deadline is June 30, 2015. The following due dates for the FAFSA should also be considered based on your state of residency:
- DE – 4/15/2015
- PA – 5/1/2015 (8/1/2015 for certain circumstances)
- MD – 3/1/2015
- NJ – 6/1/2015 if you received aid for the 2014-2015 school year (10/1/2015 for all others)
Bear in mind that this period’s FAFSA form will require a completed 2014 income tax return. If you would like to know more about section 529 plans or how they may impact your unique tax situation, please contact your tax professional for assistance with tax planning.