Divorced parents have much to think about regarding funding their dependent children’s college educations.
According to Mark Kantrowitz, publisher and vice president of research for Savingforcollege.com, an independent authority on 529 college savings plans, financial aid eligibility can be greatly impacted by which parent owns the 529 plan account for their child.
When parents are divorced, completing the Free Application for Federal Student Aid (FAFSA) is the responsibility of the custodial parent (the parent with whom the dependent student lived the most during the 12 months ending on the FAFSA filing date). If the student lived equally with both parents, which can happen in a leap year or a recent divorce, said Kantrowitz, the custodial parent is the parent who provided more support.
If the custodial parent owns a 529 account, it’s reported as an asset on the FAFSA but distributions are ignored. Need-based financial aid eligibility is reduced by a maximum 5.64 percent of the asset value, he said. If the non-custodial parent owns a 529 account, it isn’t reported as an asset on the FAFSA but distributions count as untaxed income to the student. This reduces need-based aid eligibility by as much as half of the distribution amount.
Assume the 529 account has a $25,000 balance and it’s spent to zero during freshman year, said Kantrowitz. If the custodial parent owns the account, the worst-case scenario is it reduces aid eligibility by $1,410 (5.64 percent of $25,000). If the non-custodial parent owns the account, the worst case is it reduces aid eligibility by $12,500 (half of $25,000).
There are workarounds for a 529 plan that’s owned by the non-custodial parent, said Kantrowitz, but it’s simpler if the custodial parent owns the plan.
“Obviously there may be concerns about one parent taking a non-qualified distribution to pay for a Porsche or, more realistically, for groceries and other living expenses,” he added, but court orders can require the money to be spent on the child’s education.
Parents who each agree to pay for half of college costs should specify whether that’ll be at an in-state public college or a private college, said Kantrowitz, and clarify whether they’ll split the costs after financial aid and 529 money are applied.
Kantrowitz recommended getting both parents involved in the college process. Too often, non-custodial parents feel left out but “they want to be more than just a wallet or a pocketbook,” he said. Parents should also “try to avoid using the child as a weapon against each other,” he said, because children stuck in the middle are less likely to enroll in or graduate from college.
Kantrowitz added, “There are crosscurrents when evaluating the impact of a stepparent” on aid eligibility. A stepparent’s income and assets must be reported on the FAFSA, regardless of prenuptial agreement. But if the stepparent’s kids are enrolled at least halftime in college, it can reduce the expected family contribution (EFC). “Going from one child in college to two,” he said, “is like dividing the parent income in half.”