Do You Know the Best Way to Use a 529?

Impact 529 plans on financial aid

Do You Know the Best Way to Use a 529?

Published December 28, 2019 | Last Updated July 17th, 2023 at 10:47 am

Impact 529 plans on financial aid

Having money saved in a 529 for your child’s college expenses is a huge boon.

However, it’s important to use the money the right way.

Understanding EFC implications and what expenses qualify help you avoid making costly mistakes.

How a 529 Plan Works

Everyone has a different financial situation, so it’s important to make sure you are using the 529 in a way that benefits your family best.

Before making decisions, ask yourself these important questions:

  • Who Owns the 529? A 529 owned by the student or guardians is treated differently than a 529 owned by grandparents or other family members.
  • What Aid Do You Qualify For? If you don’t qualify for need-based aid, you won’t have to be as careful about how you use your 529 because it won’t impact your need-based calculations in future years.
  • How Are the Assets Performing? A 529 allows you to invest money into a variety of assets and benefit from the gains. If the assets are performing well you may make different decisions about disbursement than otherwise.
  • Is Your Need for the 529 Reduced by a Scholarship? If your child receives a full or partial scholarship that reduces or removes your need for the 529, you can still access the money if you do it right.

EFC Impact of Using a 529

Depending on who owns the 529 and the FAFSA status of the student, a 529 and how it is used, can have different impacts on financial aid.

Parent of Dependent StudentConsidered Parent Asset, Assessed at 5.64%None
Dependent StudentConsidered Parent Asset, Assessed at 5.64%None
Independent StudentStudent Asset, Assessed at 20%None
Grandparent None50% of Distribution (in excess of annual student income allowance)
Parent of Independent StudentNone50% of Distribution (in excess of annual student income allowance)

Chart courtesy of Michael Kitces.

A 529 plan owned by a guardian or student is considered an asset for EFC purposes, but distributions are not considered income for the EFC.

On the other hand, a 529 owned by another relative is not an asset for EFC, but 50% of the distribution can be considered as income for future years’ EFC.

Using these distributions at the wrong time can cost your student dearly in future financial aid.

If your school of choice uses the CSS Profile from the College Board instead of the FAFSA, all 529s are treated as available assets no matter who owns them.

Because of the prior-prior-year rule, income years for determining undergraduate financial aid extend from the sophomore year of high school through the sophomore year of college.

This means that if you have a 529 owned by a non-custodial relative, you will want to take those distributions during the junior and senior year of college, and use the parental 529 during the freshmen and sophomore years.

Are Contributions to 529 Plans Tax Deductible?

Distributions from a 529 that are used for qualified school expenses are free from income taxes.

You can also get income tax benefits using the American Opportunity Tax Credit and the Lifetime Learning Credit, but you can’t use both tax benefits on the same college expenses.

The best bet is to use up the tax credits first, and then use the 529 funds on remaining expenses.

To avoid penalties, make sure you withdraw money from the 529 in the same year it will be used for educational expenses.

If your student is able to get a scholarship that reduces or eliminates the need for the 529 funds, you can withdraw the amount of the scholarship from the 529 each year to use for other purposes.

You will pay income taxes, but only on the capital gains. In this situation, the 529 essentially functions as an Roth IRA.  However, beginning in 2024, you can convert up to $35,000 to a Roth IRA tax and penalty-free if you’ve held the 529 for 15 or more years.

What Are Qualified Expenses for a 529 Plan?

Using 529 money for non-approved expenses triggers significant financial penalties, so it’s best to be aware of what “qualified expenses” are.

Money in a 529 can be used for tuition, books, and room and board.

Room and board expenses only qualify if your student is enrolled in school at least half-time. 

What many parents don’t realize is the number and types of schools that qualify.

If your student decides to become a chef, you may be able to use the 529 for a culinary institute. Hundreds of international schools also qualify.

Qualified Expenses

Besides room and board, your child can use money from a 529 for books, supplies, computers, internet access, and software.

Off-campus rent and groceries can also qualify, but only up to the limits of actual expenses or the allowance for room and board included in the school’s federal financial aid calculations, whichever is less.

If the apartment rent, utilities, and food go beyond that allowance, other financial resources should be used.

Unqualified Expenses

It’s vital not to be caught off-guard by the expenses you can’t use a 529 for. Approved computer software does not include games, and furnishing and entertainment costs also don’t qualify.

Most importantly, transportation back and forth to school does not count as a qualified expense. If you use money from a 529 for airline tickets, gas, or other transportation expenses it will cause financial penalties.

Are You Using Your 529 Strategically?

If you don’t qualify for need-based financial aid, you may choose to spread your use of the 529 over the entirety of college.

This is particularly true if the assets in the fund are performing well.

However, for most families it’s best to use parent-owned or student-owned 529 funds during the freshman and sophomore years, especially if you have to make up the difference with loans.

You never know how school will go for your child. Many circumstances can cause people to change their mind about college.

If your student chooses to leave college after a year or two, it’s best for them to have used the 529 instead of having debt.

It’s also best to use the parent and student 529s early in your child’s college career if you have grandparents or other relatives with 529s or available financial contributions.

Using the contributions from other family members in the junior and senior years will help avoid having need-based financial aid calculations impacted by the income.

It’s always great when a family has planned ahead and saved for at least some of their children’s college education, and a 529 is a great vehicle.

Knowing the ins and outs of the plan are crucial to your family getting all the benefits from it.


Use R2C Insights to help find merit aid and schools that fit the criteria most important to your student. You’ll not only save precious time, but your student will avoid the heartache of applying to schools they aren’t likely to get into or can’t afford to attend.  

Other Articles You Might Like:

How My Average Student Got a Full Ride to College

How Grandparents Can Pay for College with 529 Plans

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