Whenever a parent asks how to save for a child's college education, I respond by recommending he or she consider investing in a 529 college savings plan.
Almost immediately, many ask the same question: "Does a 529 plan affect the possibility of my child receiving any financial aid in the future?"
The answer to that question has changed recently, but the intent behind it always makes me wonder something: Why worry about how your savings will be treated in a 529 tax-advantaged account? Even if the earnings have the possibility of decreasing financial aid, does that mean people aren't going to save?
The mother who asked the question said she had a large sum of money that she wanted to invest in a 529 plan.
"I know you might say that if you can afford a 529, then why do you need financial aid?" she wrote. "Well, I am a single parent and when the time comes for my 6-year-old to go to college, I am going to seek any and all resources available."
It's not that I'm not unsympathetic to this parent's concern. Heck, I'm sure going to apply for every free dollar I can get for my children when they are ready for college. I'm praying my children get scholarships to college or qualify for financial aid. But at the same time I do not fear the probable, which is the likelihood that their education will be all on me and my husband.
I'm not worried about free money, and here's why: Who knows what federal dollars will be available by the time my children go off to college?
Nonetheless, all those who do worry about how 529 plans will affect federal aid, rest easy - at least for now.
Thanks to the Deficit Reduction Act of 2005, a 529 plan - whether it's prepaid or a savings plan - is now considered a parental asset in the determination of federal financial aid. That change became effective as of July 1.
This change is a good thing.
The government expects parents to contribute to their child's education. This is called the expected family contribution, or EFC. When families fill out the Free Application for Federal Student Aid or FAFSA (which you can do beginning Jan. 1), the information provided is used to calculate a student's eligibility for federal and state financial aid, as well as for college aid packages. The EFC calculation also includes your family's income, assets and benefits, family size and how many family members are attending college.
On a sliding scale, parents are expected to contribute a maximum of 5.64 percent of their assets and income to their child's college education. Retirement accounts and insurance products are not counted, said Joseph Hurley, founder of SavingforCollege.com.
Students are expected to contribute 35 percent of their assets and 50 percent of their income. Here, too, is some good news. Next year the student contribution will drop from 35 percent to 20 percent.
Interestingly, a 529 plan owned by a student or within custodial accounts, which can be opened under the Uniform Gifts to Minors Act or the Uniform Transfers to Minors Act, is not counted at all in the federal formula.
In addition, tax-free withdrawals from 529s are not picked up as income for financial aid purposes, Hurley says. "Contrast this 529 treatment to gains on sales of mutual funds that are picked up and count as much as 50 percent if student income or 47 percent if parent income," he said.
All of this just applies to federal financial aid. Non-federal aid can use different formulas, and colleges and universities can treat 529s however they want for their own institutional financial aid programs.
The fact is it's impossible to predict how financial aid formulas will be used by the government or the colleges, so don't plan your savings around what your child might get in free money or loans or even work study.