If you do the right thing and plan for your child or grandchild’s college education by contributing to a 529 plan, you would expect that to be a good thing, right? However, a 529 is frequently what you shouldn’t do. The truth is, a 529 plan can have negative consequences and make college more expensive.
With a 529 plan, assets grow tax-free. The financial firms love tax-free growth because it leads to bigger account balances and higher management fees. The longer term nature of 529 plans also provide for more fees. These firms do not discuss the negative effects of a 529 plan, a further extension of the self-serving nature and conspiracies of these firms.
The fact that savings in a 529 college saving plan can increase college costs may sound improbable, if one doesn’t fully understand how college tuition is paid. Nevertheless, contributions to a 529 college saving plan can truly increase the cost of college. First, you must consider that college tuition often depends on what the student and their family can afford. What you end up paying is not the stated tuition, but is instead the Expected Family Contribution (EFC).
Most schools request parents to complete a FAFSA form, which stands for Free Application for Federal Student Aid. What you disclose on your FAFSA determines what you pay for college cost, which is the Expected Family Contribution (EFC).
Wall Street does not train advisors on how to structure assets for FAFSA calculations in a way to benefit parents. Instead, Wall Street just asks parents to invest more money in 529 plans for college which generate more investment management fees for the firms. This is shameful in this case because it can increase college cost for the family.
Often, higher earning parents don’t even bother to file a FAFSA because they just assume there would be no benefit for them, yet frequently they can qualify for benefits, if they know how to structure their income and assets.
The FAFSA form is more like a search for family savings assets than an income review. A higher income by itself may not disqualify the family. In fact, the FAFSA form does not ask for the parents’ gross income. It instead asks for the IRS reported Adjusted Gross Income (AGI) which can be manipulated. Many expenses can reduce AGI. Investing more in your business, making improvements or borrowing more on your rental real estate can reduce cash flow and lower your AGI. The FAFSA form asks for actual taxes paid which reflects on the deductions you have. A higher mortgage expense and other itemized deductions can reduce taxes paid. The number of college students in the household also affects FAFSA calculations. But remember, family income is not the biggest factor in determining your EFC. Your family’s savings and investing accounts are the biggest factor.
The savings component on the FAFSA is more important than the income for most families. This is fortunate because savings and investments are easily restructured for favorable FAFSA calculations. The first thing FAFSA calculations review are savings held for the child’s education expenses, such as 529 education savings accounts. They assume that the majority of the savings held for the child’s education expense will be extracted for expense before tuition aid is considered.
In contrast, if the same money is held in the parents’ name, the FAFSA calculations assume a much smaller percentage (about 75% less, depending on several factors) is available for college expenses. This means that saving money in the parents’ name may result in a reduced EFC, and/or an increase in grants and other support, when compared to having the same amount of money in a 529 plan. Of course, you don’t get the same tax benefits as a 529 plan, but other tax advantage solutions are possible.
It is possible to eliminate most of the parents’ savings from the FAFSA calculation because of the very narrow way FAFSA calculates funds available for college expenses. Most colleges do not consider the value of the parents’ home, money held in life insurance, annuities, or in other tax-deferred retirement plans (IRA, 401[k], and pension funds) as available to support children’s college expenses. They see that money as sacredly devoted to retirement or death benefits and absolutely not available for college expenses. Therefore, moving parent’s savings into these types of accounts, even if they are only moved temporarily for the college years, removes these assets from the FAFSA calculations and makes tuition aid far more likely.
A possible much better investment than a 529 plan is to sit down with the right financial planner that can show liquid methods for structuring assets for favorable FAFSA calculations. Maybe your child, if academically qualified, can afford to go to Harvard, Yale or Stanford Universities for a very low cost.