College Savings Updates (It's not all boring!)

It’s back to school! In between buying school supplies for my girls and helping them plan their first-day-of-school outfits, I am thinking about investing and their future education goals.

We often hear about 529 plans being useful savings tools for college, and they can be, but how do they affect a student’s ability to get financial aid?

A quick refresher – 529 accounts are an education savings tool. Investments in the accounts are able to grow tax-free. In addition, withdrawals are tax-free if used for qualified education expenses, which means that any gains in the account are effectively tax-free if used for education expenses.

On the FAFSA (Free Application for Federal Student Aid), parent-owned 529 accounts are considered part of parental assets and can reduce aid eligibility up to 5.64%.

Example: A $20,000 529 account could reduce aid by up to $1,128.

My general recommendation for parent-owned 529 accounts is to contribute enough to take advantage of any state tax deductions or credits. Since this doesn’t apply to some states, it may not make sense to open a 529 account for your kids. It may be best to utilize other saving tools, such as a taxable account in the parent’s name that can be used for education expenses but doesn’t have to be.

However, my recommendation changes for grandparent-owned 529 accounts. Grandparent-owned 529s aren’t included in assets on the FAFSA. Also, thanks to a change in rules, distributions no longer affect the student’s financial aid. Prior to the 2024-2025 school year, distributions from a grandparent-owned 529 could reduce the student’s financial aid package by up to 50%. That is no longer the case! Under the updated rules, assets of and distributions from grandparent-owned 529 accounts are not reported.

In states where there is a state tax credit or deduction, grandparents contributing to 529 accounts for their grandkids can take advantage of this as well! All of this to say, 529 accounts can be a useful tool to gift money to grandkids.

While I remain relatively neutral on using 529 plans for education expenses and believe that it depends on many partner-specific factors, they do have another perk that began in 2024 thanks to SECURE Act 2.0. You can roll over up to $35,000 of unused 529 funds into a Roth IRA tax-free and penalty-free. A few rules:

• The 529 beneficiary must own the Roth IRA and the transfer must be direct from the 529 to the Roth IRA – it can’t go to the 529 owner or beneficiary first.

• The 529 account must be at least 15 years old

• Rollovers are limited to the annual Roth IRA contribution limits ($7,500 for 2026; $8,600 for those 50 and older).

• The beneficiary must have earned income equal to or greater than the rollover amount that year. If the beneficiary only has earned income of $5,000, then their rollover amount to the Roth IRA is limited to $5,000.

Example: Grandma sets up a 529 account for her granddaughter, June. Between contributions and growth in the account, June has $60,000 in the account when she goes to college. However, she only uses $35,000 of it. June begins working after college and has enough in earned income to contribute to a Roth IRA each year. Instead of Roth contributions out of cash flow, Grandma rolls over $7,500/year until the remaining $25,000 is in June’s Roth IRA rather than sitting unused in the 529 plan.

While my girls aren’t near college age yet, I’m still thinking about how I’ll be handling that cost in the future. For now though, I’m taking a walk down memory lane and looking at pictures from their early school years, when my girls loved to smile as awkwardly as possible in back-to-school photos, and my youngest’s backpack seemed bigger than her.