How to Balance the Three-Legged Stool of 529 Plans, Financial Aid & Retirement Savings

529 Plans, Financial Aid Award Packages & Retirement Savings

Sallie Mae’s 2018 How America Saves for College Survey shows 529 Plan contribution amounts nearly doubled between 2016 and 2018. Preparing for the future is always a smart financial move. But, are you placing too much emphasis on saving for your child’s future college education at the expense of your retirement savings? Understanding how 529 Plans and your student’s financial aid award package impacts your retirement savings is key to making contributions that reduce dependence on student loans while ensuring a financially sound retirement. Here’s what you should know to avoid allocating too much to a 529 Plan.

Financial Aid Award Packages: The Basics

College students are often required to complete the Free Application for Federal Student Aid (FAFSA) to assist institutions in determining their eligibility for financial assistance each academic year. Based on the information provided in the FAFSA, a student’s Expected Family Contribution (EFC) is calculated to identify financial need. Students who meet application deadlines, set by their college or university of choice, receive a financial aid award letter in early Spring detailing the types and sources of funding they are eligible for based on these factors:

  • Cost of Attendance (COA) includes tuition and fees, room and board, estimated living expenses and other costs determined by the institution.
  • Expected Family Contribution (EFC) is a figure based on data in the FAFSA and used to determine financial aid eligibility.
  • Financial Need is determined using formulas applied to the COA and EFC.

These factors work together to help create an appropriate financial aid award package:

COA Minus EFC Equals Financial Need

A financial aid package will vary depending on the federal, state, and institutional programs offered by the college. Outside aid such as private scholarships may be considered when determining the financial aid award. Colleges and universities that offer institutional scholarships and participate in the Federal Student Aid program may offer a package to a student that includes these types of financial aid:

  • Grants do not be repaid and are awarded based on need.
  • Loans require repayment, with interest, and might be based on need.
  • Scholarships do not require repayment, but are limited and are often based on eligibility criteria such as academic achievement, athletic accomplishments or other requirements.
  • Work-Study is another form of need-based aid which need not be repaid. The educational institution administers this program. Eligible students are awarded a set amount but must work for an employer to receive the aid.

The financial aid package bridges the gap between what the student is expected to contribute and college costs for the federal award year. Students may decline aid listed in the financial aid award letter. Unfortunately, eligible college students often decline one of the most misunderstood and often underutilized forms of financial assistance available. 

The Most Misunderstood Financial Aid Award

Federal Work-Study is a need-based award that more students should consider to help pay for college. Not every college or university who participates in Federal Student Aid programs offer Federal Work-Study, but the ones that do receive a limited amount of dollars to award students. Students and parents should keep the following in mind if they have an opportunity to accept an often-underutilized way to pay for college:

  • Due to the limited availability of work-study funds, students are encouraged to complete the FAFSA early, accept the award amount, and work with the institution to secure a work-study position.
  • Work-study funds are received like a typical paycheck. The student works the hours at an approved work-study job site and is paid based on hours earned up to the designated financial aid award amount. These funds are not automatically applied to tuition or other college-related expenses but are meant to help with the costs of higher education.
  • The student will need to apply each year. A prior award of work-study does not guarantee future awards.
  • Federal Work-Study can reduce the need to accept loans as part of the financial aid award package.

The process of applying for a work-study job varies by the educational institution. Students should speak with a financial aid office representative at their chosen institution for details. Work-study employment jobs also provide valuable work experience.

What are 529 Plans?

A 529 Plan, aka “qualified tuition plan”, is a tax-advantaged account designed to help you prepare for the costs of higher education. Plans can be used to prepay educational expenses or to invest and save for qualified educational expenses. For Tax Year 2018, the maximum annual contribution amount is $15,000. These contributions grow tax-free. Distributions or withdrawals for qualified educational expenses are also tax-free.

Investors favor 529 Plans since they can reduce the student’s dependence on loans. When eligible students accept the Federal Work-Study reward, the reliance on student loans is further reduced if not eliminated. Starting life after college with little to no loan debt can put your student at a distinct financial advantage as they begin life on their own.

The 3-Legged Stool of Financial Aid Awards, 529 Plans and Retirement Accounts

Financial aid award packages vary each year based on the information submitted in the FAFSA and the financial aid programs available at the college. If FAFSA data significantly changes each year, e.g., income, household size, etc. the award package is likely to do the same. Accepting grant, scholarship, and work-study awards can help reduce a student’s reliance on loans. If a student is ineligible for such rewards, there will greater dependence on a 529 Plan to minimize potential student loan debt.

529 Plans come with significant financial benefits for the account owner. Plan earnings are tax exempt on your federal tax return. Individual states may offer additional benefits. With state income tax deductions and tax credits available to eligible account owners, it’s tempting to over-allocate to 529 Plans at the expense of your retirement investments. However, it’s essential to earmark funds for non-qualified accounts, i.e., investment accounts with no tax benefits, such as annuities, REITs (real estate investment trusts), stocks, and bonds. These investments typically have no annual investment restrictions and can bolster your retirement financial portfolio.

While retirement savings accounts do not need to be reported on the FAFSA, they should be taken into consideration when aligning your plans to pay for college alongside your long-term financial goals. For example, if you’re eligible for a Roth IRA, it may make sense to contribute enough to the 529 Plan to receive the appropriate local and state tax benefits while still funding your Roth IRA, instead of directing everything to the 529 Plan. A Roth IRA contribution is not tax deductible, but since you contribute using after-tax dollars, you are not taxed on qualified withdrawals. Tax Year 2019 has set contribution limits at $6,000 (or $7,000 if your age is 50 or older).

Simultaneously investing for your student’s future education and your retirement can be challenging. Balancing these two large financial commitments requires an examination of your education savings allocations, your student’s financial aid award package each year, and your retirement contributions. Are your investment decisions leading you closer to or further away from your financial goals? A Certified Financial Planner® professional can review your specific financial situation to help determine how to make the most of your resources and develop a tax-efficient strategy to pay for college


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