Yay, my kid won Scholarship! Now what happens to my College Savings?

Many of us have a college savings plan for our kids higher education. When your kid starts applying for college, how does the savings impact their chances of winning a scholarship? Another question that comes up is if your kid gets a merit scholarship to attend college, what happens to all the money you saved? Would you lose all or part of it?

Let us explore these questions and find out.

To know more about what a college savings 529 plan is, go here.

Scholarships

A college student may be eligible for scholarships, grants or financial aid. Typically scholarships are provided based on students' merit or their athletic excellence. Such scholarships are generally not determined based on the ability of the family to support college. The technical term for the ability of family to support college is called Expected Family Contribution or EFC. Some scholarship granting institutions look at EFC to determine the amount of scholarship the child is eligible for. However, this is not typical. Most scholarship granting institutions provide merit based scholarships no matter how much the family can support or not.

Grants, especially needs based grants, and financial aid on the other hand typically are influenced by EFC. Savings under the 529 plan impact the EFC calculation. If a parent holds the 529 account with the beneficiary as the college student, the EFC calculation uses a portion of the savings under the 529 plan. Typically it excludes the first $20,000 (this varies based on the age of the parents). For the rest of the amount in the plan, it treats 5.64% of this amount as EFC for every college year. Lets us do a quick example. If we have $50,000 in our 529 plan, after excluding the first $20,000, our EFC will be 5.64% of $30,000 or $1,692. The aid that the child could otherwise be granted may be reduced by this amount. This amount is likely only a small fraction of the interest the student may pay on student loans after graduation.

Kid wins Scholarship, what now?

Say, your college going kid gets qualified for a merit based scholarship that is tax free. How does that impact your 529 plan savings? You may not use all of this savings for the college expenses and likely there is money left over in the plan. Here are some of the alternatives you have:

• You can change the beneficiary to one of their siblings and use the amount toward the sibling's college expenses.
• You can keep the savings until the student enters graduate school and use the money to pay for graduate education.
• You can take out the money from the plan and move it over to a taxable savings or brokerage account. When you do this, you will pay tax on the amount excluding your original principal. Additionally, there may be a 10% tax penalty for not using the funds for college expenses. However, if your child received merit based scholarship that is tax free, you are exempt from this penalty up to the amount of scholarship that was used for qualified college expenses

The intent of these rules is to encourage you to save money for college, not to penalize you for having saved the money. You are no worse off than using a regular taxable account to save for college.

Kid abandons college plans. What happens now?

Even if the kid quits planning for college, the 529 plan can be used towards a wide variety of education related expenses. If the kids needs vocational training, it is possible the 529 money pays for that training without incurring a penalty.

All the other options discussed above are also applicable except for the scholarship exemption.

Conclusions

In conclusion, 529 plan offers a great way to save for college while also benefitting from the tax sheltered status. The intention behind the plan is benign and the impact of losing the savings upon securing scholarships is remote. Even if the money is not used for college expenses for the intended kid, there are multiple options to continue the savings and use for future college related expenses for siblings or family.

As you work through setting up the 529 plan for your kids, we are here to help answer any questions you may have.