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Free Money? - Less Tax - College Funding!

SD Medallion Services|Wealth Management

By Victoria Rogers

If you think you can fund your student’s education with free money, you may be sadly mistaken.  Only 0.3% of college students receive grants and scholarships to cover all costs.  Up to 44% receive some type of free money, grants averaging $6,600, or scholarships averaging $8,000.1

If you are ignoring the planning benefits of 529 plans, you may be missing out on free money.

  • A 529 grows tax-free for federal and state purposes, and will never be taxed when used for eligible higher education expenses.
  • If you are a PA resident, contributions to any 529 plan provide you a tax deduction up to $14,000 per year (equal to the federal annual gift exclusion).
  • A PA 529 plan is free from Pennsylvania Inheritance Tax. 
  • The five-year gift tax election allows contributions up to $70,000 in the first year. 
  • A 529 is a considered to be a completed gift for federal gift tax purposes.

529s are especially powerful if you are a grandparent.  You can fund a plan and receive the tax deduction.  It’s removed from your estate, and potentially exempt from Pennsylvania inheritance taxes.  Now consider the following timing to maximize benefits.  Your grandchild will most likely be required to complete the Free Application for Federal Student Aid (FAFSA), which is the official form used to access federal, state and school level grants, scholarships and loans.  The FAFSA includes both the parents’ and student’s assets and income in calculating the expected family contribution. The 529 under your ownership will not be considered an asset for your grandchild.   

Keep in mind, however, that the FAFSA always looks back at prior-year transactions. Year one can be completed without any impact to the student’s aid.  Subsequently, any distributions from this plan will be considered income to the student (since the asset is not recognized). In the FAFSA calculation, 50% of a student’s income above $6,260 will be considered.  If your student does not have other income, this may not be a burden.  If there is other income, hold distributions until the student’s final year without impacting his potential aid.  If you planned on funding the majority of his/her college career, obviously this timing is inadequate, but your grandchild most likely does not need the aid.

A better option in this case would be to change the account owner to the student’s parents at least one year before college entrance.  This is not a gift to the parents, since you have a completed gift.  Accounts in the parents’ names are recognized for FAFSA up to a rate of 5.64% of the value.  The parents can distribute the funds as needed.  Distributions from recognized assets are not considered income. 

There is a lot to consider. With some creativity, you may not find free money, but you can certainly minimize tax burdens and maximize student aid.

Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as investment, tax or legal advice.  Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary.  Therefore, the information should be relied upon when coordinated with individual professional advice.

1 JPMorgan College Planning Essentials Guidebook

© 2014 Schneider Downs. All rights-reserved. All content on this site is property of Schneider Downs unless otherwise noted and should not be used without written permission.

This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.

Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.

© 2018 Schneider Downs. All rights-reserved. All content on this site is property of Schneider Downs unless otherwise noted and should not be used without written permission.

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