In an interview with CNBC, Robert Helgeson, director of financial aid for Valparaiso University in Indiana says, "In the federal formula that determines how much financial aid a student receives, there are asset protections for money in a parent's name that are not there for money in a student's name. For example, if a parent has $100,000 in assets, the government is going to expect them to contribute $6,000 of it to education. If a student has $100,000 in assets, the government will expect $20,000."
Because a student's financial aid is based on their income and assets from the year prior to applying for financial aid (in many cases, this is their junior year in high school), students with a large sum of money in their name, may be ineligible for receiving financial aid.
Fortunately, there is a way for parents to save for college that won't put your child's financial aid in jeopardy. Enter the 529 plan.
What is a 529 plan?
A 529 plan is a savings option that can help you strategically set aside money for college. Named after the IRS code section that created them, a 529 plan is a tax-advantaged investment plan that's designed to encourage saving for future higher education expenses of your beneficiary (typically a child or grandchild).
A 529 plan is administered by state agencies and organizations as a way to save for qualified educational expenses such as tuition, room and board, and textbooks. Moreover, because it is the parent who owns the account, a 529 is considered part of the parent's assets - not the student's.
A 529 plan keeps you in control of the money. So if your child decides not to go to college, he or she won't have access to the money unless you want them to. However, if you don't use the money for education expenses, the IRS will charge income tax plus a 10 percent penalty on your investment earnings. While that's not always great for your investment, it does provide a little peace of mind in knowing that you can access the money if your plans change.
In addition to the savings benefits of 529s, are the tax benefits. All withdrawals from 529 plans for qualified education expenses will remain free from federal income tax. Also, many states mirror the federal tax advantages for 529 plans by offering state tax-deferred growth and tax-free withdrawals for qualified higher education expenses.
There are many pieces in the college savings puzzle and not every plan fits every family. Your particular circumstances determine what's best for you.
NOTE: As of 2018, the IRS has amended the term “qualified higher education expense” to include a limited amount of annual expenses from a 529 Plan for tuition at an elementary or secondary public, private, or religious school. Source: https://www.irs.gov/newsroom/529-plans-questions-and-answers