Eligible Expenses:An account owner may initiate a tax-free distribution on behalf of the beneficiary for “qualified” college or graduate school expenses (in most states). Elementary and secondary education is not a qualified expense in the Section 529 plans, unlike the Coverdell ESA.
The IRS rules for Section 529 qualified expenses, while still being fairly liberal, are more strict than the Coverdell as well:
- Room and Board (student must be enrolled at least half-time)
- Computers / Laptops (only if the school requires them)
- Books and Supplies (as required by the university)
Effect on Federal Financial Aid Eligibility:Section 529 accounts have a minimal effect on Federal financial aid, as they are considered an asset of the parent. As such, 5.64% of their value is counted against financial aid eligibility.
Additionally, some states (IL, IN, KY, NY, PA, and VA) completely exclude Section 529 assets from eligibility for state funded financial aid.
If the owner is a grandparent, member of extended family, or unrelated individual, it is argued (but hasn’t been tested by a court), that the assets do not count against financial aid at all. This is due to the fact that there is no place to report assets owned by people other than a parent or student on the FAFSA form.