Awarding Scholarships Using 529s: FAQs and Expert Insights
As scholarship providers, finding efficient, flexible, and sustainable ways to support students is always a top priority. One such avenue that continues to grow in popularity is the use of 529 plans for scholarship distribution. Whether you're considering 529s for the first time or looking to deepen your understanding of how they work, this blog post is here to provide clarity. We’ve compiled the questions most frequently asked of us about 529 plans, their benefits, and how they can help streamline the scholarship process for both providers and students. From minimizing risk to ensuring tax advantages, 529 plans offer a wealth of opportunities. Let’s dive into the essential details so you can make the most informed decision for your scholarship program.
The Basics
What is a 529 plan?
A 529 plan is a tax-advantaged savings account specifically designed to help families save for educational expenses. There are two types of 529 plans: prepaid tuition plans and education savings plans. Scholarship providers typically use education savings plans, which can cover a wide range of qualified educational expenses.
Why are they called 529s?
The term “529” comes from Section 529 of the Internal Revenue Code, which governs these plans.
What can 529s be used to pay for, without any negative tax consequences?
529 funds can be used for a variety of educational expenses, known as “qualified education expenses”, including:
Tuition and fees
Room and board
Books, supplies, and equipment
Computers, technology and internet required for coursework
Special needs services
Graduate school tuition
Student loan repayment (up to $10,000 lifetime limit per beneficiary)
Retirement (up to $35,000 lifetime limit per beneficiary)
For more information, visit SavingForCollege.com’s guide.
Can students have multiple 529s?
Yes, students can have multiple 529 plans. There is no limit to the number of 529 accounts a student can have, whether the accounts are owned by different people or organizations. For example, a student may have one 529 plan owned by a parent, another owned by a grandparent, and a third one through a scholarship provider or foundation.
However, while there is no limit to the number of 529 plans a student can have, there are annual contribution limits set by the IRS for each account. These limits are based on the beneficiary's state of residence and the specific 529 plan's rules, but they do not apply to the total amount a student can accumulate across all of their accounts.
What are the state-specific 529 plans?
Each state, except Wyoming, offers its own 529 plan. These plans may have different investment options, contribution limits, and state tax incentives. Many states offer a state income tax deduction for contributions made to their state’s plan. Additionally, some financial institutions, such as Fidelity and BlackRock, also offer their own 529 plans. These plans may provide different investment strategies, but they all share the same tax benefits and rules governed by federal law.
How 529s Work
How can 529s be set up?
529 accounts can be set up for any potential student, meaning the individual does not need to be enrolled or admitted to a school at the time the account is opened. 529 plans can be set up for students of any age, from young children to adults, as long as the funds are used for qualified educational purposes in the future. This makes 529s a versatile tool for both scholarship providers and families who want to support education at any stage.
In general, there are two different account ownership options: organization-owned student beneficiary accounts, whereby the organization would own the student’s account, or student-owned student beneficiary accounts, whereby the organization would contribute to an account the student owned. There are pros and cons to both options, and ownership decisions are a key decision point for those offering scholarships through 529s.
Can 529 plans be used for students who are not yet enrolled in an institution?
Yes, 529 plans can be set up for any student—regardless of whether they are already enrolled in school. A student doesn’t need to be admitted or enrolled in a program to have a 529 established on their behalf.
How quickly can scholarship funds be distributed using a 529?
Disbursement of funds can happen very quickly, often within just a few days after the initial setup. This allows students to receive funds much faster than through traditional scholarship awarding methods, ensuring timely access for tuition and other expenses.
How are 529s regulated?
529 plans are regulated by the IRS under Section 529 of the Internal Revenue Code. The IRS establishes the rules governing the tax advantages, contribution limits, and the types of tax-advantaged qualified educational expenses that 529 funds can cover. Although the federal government sets these guidelines, each state may offer its own specific 529 plan, which can include different investment options and state-level tax benefits.
How do 529s minimize market risk for scholarship providers?
Since contributions to 529s are typically made and withdrawn within a short timeframe, there is minimal exposure to market risk. Furthermore, many scholarship providers choose to use low- or no-growth investment strategies within the 529 plan, minimizing volatility and ensuring that the funds are available when needed.
Can payments be made to the student or their college/university?
Yes, payments from a foundation-owned 529 plan can be made payable either directly to the student or to their college/university. When payments are made to the institution, one of the key benefits is that the funds are routed through a 529 plan provider’s financial institution (e.g., Fidelity, TIAA). These payments appear as checks from the financial institution, not as payments from an outside scholarship provider. This helps avoid issues of displacement because there is no visible indication to the institution that the payment is coming from an external scholarship provider.
Can a scholarship provider control how the funds are used by students?
Yes, scholarship providers can set guidelines on how funds are used within the 529 plan. While the IRS sets the rules for what constitutes a qualified educational expense, scholarship providers can establish their own policies and processes that restrict the use of funds to match the specific criteria of their scholarship, such as covering only tuition or books, or limiting the scholarship to undergraduate expenses.
What happens if a student doesn’t use all the funds in their 529?
If the scholarship provider owns the student’s 529 plan, they can either reassign the unused funds to another eligible student or allow the original student to retain the funds for future educational use, such as graduate school or loan repayment. If the student owns the 529, they have the flexibility to use the remaining funds for either qualified educational expenses or non-qualified expenses. If used for non-qualified expenses, only the earnings portion would be subject to taxes and penalties, not the principal.
How do 529 plans benefit scholarship providers in administering payments?
529 plans simplify fund management by ensuring compliance with tax regulations and minimizing administrative complexity. The plan providers and their financial management partners, such as Fidelity or TIAA, handle most of the logistics, including tax documentation, reporting, and recordkeeping. This reduces the burden on scholarship providers and ensures that funds are disbursed efficiently and in compliance with IRS guidelines. Should the provider choose to, they can keep funds in 529 plans to enable tax-free growth, providing the potential for added value over time.
Are there any tax implications if a student uses the funds for non-qualified expenses?
If a student uses their 529 funds for non-qualified expenses, only the earnings portion of the funds will be subject to federal income taxes and potentially a 10% penalty. The principal (the initial contributions) remains unaffected and is not taxed.
Do 529s affect financial aid?
529s owned by third-party providers, including foundations or organizations offering scholarships, typically do not count toward a student’s assets or income for financial aid purposes. This ensures that students can receive the scholarship funds without negatively impacting their eligibility for need-based financial aid. However, student-owned 529 accounts may have an impact on a student’s financial aid, since they are considered a resource of the student instead of the third-party.
Why not make scholarship payments to colleges and universities directly?
Paying institutions directly may create challenges, including displacement issues, where students' other financial aid is reduced due to the scholarship. Displacement can lead to confusion or frustration for both the institution and the student, as the total amount of aid a student receives may not reflect their actual financial need. Additionally, scholarships, fellowships, and similar grants to individuals are the only form of charitable giving that imposes a potential tax penalty on recipients. If paid to an institution and used for indirect expenses, including some living expenses, scholarships are taxable to recipients (same as in cases when paid to students directly). Furthermore, handling scholarships through institutions can be administratively complex, and funds are often distributed on a set schedule, which may delay the students' access to funds.
By paying students directly through a 529 plan, scholarship providers can avoid these displacement challenges and ensure that students receive their funds more promptly. Direct payments to students also allow for a more flexible approach to how the funds are used, within the guidelines set by the scholarship provider, and can result in fewer complications with institutional processes.
Why not make scholarship payments to students directly?
Again, scholarships, fellowships, and similar grants to individuals are the only form of charitable giving that imposes a potential tax penalty on recipients. Scholarships that are paid directly to students thus may cause a tax liability for recipients, for example, if used for some living expenses (same as in cases when paid via institutions).
Benefits to Scholarship Providers
Why should scholarship providers use 529 plans?
529 plans are a highly efficient and flexible way for scholarship providers to manage and distribute funds to students. Some key benefits include:
Tax-free withdrawal of funds when used for qualified educational expenses.
Quick disbursement, with distribution to students within a few days, much faster than traditional scholarship disbursements.
Minimal market risk, since funds are typically contributed and withdrawn within a short time frame with minimal exposure to market fluctuations.
No impact on financial aid, as funds in a 529 owned by a scholarship provider do not count toward a student’s assets or income for financial aid purposes.
Student motivation, because even a small amount of money saved in a 529 has been shown to increase college enrollment rates.
Benefits to Students
How do 529s benefit students in terms of persistence and college enrollment?
Research shows that stable financial support is linked to increased persistence in higher education. Even a small amount of money in an educational savings account has been correlated with four times the likelihood of a student enrolling in and attending college. Therefore, scholarships administered through 529s not only provide immediate financial relief but also serve as a motivating factor for students to pursue higher education.
How can 529 plans create multi-generational impact?
Since 529 plans can be established for students of any age and can be used for both undergraduate and graduate education, they offer scholarship providers the opportunity to create lasting, multi-generational impact. Furthermore, student-owned accounts are transferable to other beneficiaries, such as their children. Contributions to a 529 plan can benefit not just the student receiving the scholarship, but potentially their family members or even future generations, continuing to support education and lifelong learning.
How do 529 plans foster financial literacy for students?
529s offer a valuable opportunity for scholarship providers to engage students in learning about financial management. By participating in a 529 plan, students gain insight into savings, taxes, and long-term financial planning, helping them become more financially literate. This could lead to more informed decision-making regarding their finances as they navigate their education and future career paths.
How do 529 plans empower students with more control over their scholarship funds?
529 plans provide students with greater autonomy in managing their scholarship funds. While scholarship providers can set guidelines, students have the flexibility to decide how to use their funds within the IRS-approved list of educational expenses. This means students can make decisions that best align with their immediate educational needs, whether for tuition, books, or even future expenses like graduate school or certification programs. The long-term nature of 529s allows students to plan and allocate funds as needed throughout their educational journey.
How do 529 plans support nontraditional students?
529s offer flexibility in supporting a wide variety of students, including nontraditional students. Scholarship providers can use 529s to assist adult learners, career changers, or those pursuing certifications or part-time degrees. This allows providers to meet the needs of students at various stages of their educational journeys, increasing access to educational opportunities for a broader demographic.
Can anyone contribute to a student's 529, and what are the benefits of this?
Anyone can contribute to a student's 529 plan, regardless of whether the plan is owned by the student, a foundation, or another third party. This means that family members, friends, and even organizations can support a student’s educational journey by making contributions to an existing 529 account.
If you’re interested in learning more about how 529 plans can enhance your scholarship program or want guidance on implementing them at your organization, reach out to Students First Consulting. Our team can help you design a solution that aligns with your goals, ensuring a smooth and effective process for your team and students. Schedule a consultation today.
