NEW LAW affecting 529 Plans (State College Savings Plan.) 529 Plans are a wonderful way to save for college but many worried about how they would count against a child's financial aid needs. Here is a great bit about the new law affecting 529 plans-It's good news for those that like to save!

How will a 529 plan affect my child's chances to qualify for financial aid?
A new law enacted in early 2006 (Deficit Reduction Act of 2005) made substantial changes to the treatment of 529 plans in the federal student aid eligibility formula. The changes are first effective for the 2006-07 school year.

Before these changes, we relied on guidance from the U.S. Department of Education stating that a 529 savings account is treated as an asset of the parent or other account owner in determining eligibility for federal financial aid. This was generally considered good news because it meant that your expected contribution towards your child's college costs would count only 5.6 percent, or less, of the value of any 529 account of which you are the account owner. However, a 529 account owned by your child, including a "custodial" 529 account funded from an existing UGMA/UTMA account, was still considered to be a student asset. Students assets are assessed in the financial aid formula at a much higher 35 percent rate (this rate decreases to 20 percent beginning with the 2007-08 school year).

The new law now prevents a 529 account from being treated as a student asset on a FAFSA filed by a dependent student. This means a custodial 529 will no longer be subject to the 35 percent assessment rate. In fact, it shouldn't be included on the FAFSA at all. The transfer of UGMA/UTMA assets from taxable investments into a 529 plan can immediately produce much higher eligibility for federal financial aid. Even if Congress decides that this result was not intended, and enacts further changes to eliminate the "loophole," the worst case is likely to be treatment of the student-owned 529 account as a parent asset. This would still produce a substantial benefit.

Along with favorable asset treatment, a 529 account also garners favorable treatment in the income portion of the financial aid eligibility formula. A tax-free distribution from a 529 plan to pay this year's college expenses will not be part of the "base-year income" that reduces next year's financial aid eligibility. If the 529 tax exclusion goes away at the end of 2010, as it is currently scheduled to do, this financial aid benefit may disappear as well.

Here is a simplified example of how this all works: You file the FAFSA aid application when your child is a senior in high school. Let's say you have a 529 savings account (you are the owner, not your child) with $20,000 in it, of which $10,000 represents your original contribution and $10,000 is earnings. Your eligibility for federal financial aid this year will decrease by no more than 5.64% of the account value, or $1,128. Assume there is no further appreciation in the account and you withdraw $5,000 in the Fall to pay for the first semester college bills. If you have $15,000 left in the account when you apply for aid for sophomore year, you will again be assessed up to 5.64%, or $846, of the account value. The $5,000 withdrawal brought $2,500 of excluded earnings with it, but as indicated above, none of the withdrawal is counted as financial aid income. The federal aid formula is even more complicated than what is described here.

Another major change in the new law is the way a 529 prepaid tuition plan is treated. Under the old law, your investment would not show up at all on the FAFSA, but the benefits paid out would be considered by the institution as a resource that reduced your child's overall financial "need". The bottom line effect for most families was a dollar-for-dollar offset in eligibility.

Going forward, a 529 prepaid tuition plan will be treated the same as a 529 savings plan. It will no longer cause a dollar-for-dollar reduction in financial aid. Instead, the reduction will be no more than 5.6 percent of the refund value of the prepayment account.

Sound complicated? It is. And we are only talking about the federal financial aid rules here -- each school can (and most will) set its own rules when handing out its own need-based scholarships, and many schools are starting to adjust awards when they discover 529 accounts in the family. Also consider that the federal financial aid rules are subject to frequent change. Finally, remember that most financial aid comes in the form of loans, not grants, and so you end up paying it back anyway.
Source: http://www.savingforcollege.com

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