How Investing for Kids Impacts Financial Aid

As a parent, you have many options to help your child start their adult life on solid financial footing. Start talking to kids about money early? Check. Involving them in plans for their education? On it. But sometimes, parents worry that various financial goals may not work well together. When it comes to investing for kids, a common concern is that investment funds could negatively impact their chances of receiving a good financial aid offer for college.

While student-owned accounts can reduce some types of financial aid, investing for your kids may have less negative impact on financial aid than you expect. Many families find that planning for their child’s financial future, including investing, offers more advantages than focusing solely on maximizing financial aid.

How Student Assets Impact Financial Aid

When your child goes to college, you’ll likely fill out the Free Application for Federal Student Aid (FAFSA) to apply for financial aid. Most colleges use the FAFSA to calculate need-based aid. If your child is your dependent when they complete the FAFSA, the application will consider both your income and assets, as well as your child’s, to calculate the expected family contribution (EFC), which affects how much need-based aid colleges will offer.

Not all assets count toward your EFC. Your family home, retirement plans, and life insurance value are excluded from aid calculations. Some investment accounts for your child, such as UGMA or UTMA accounts, do count as assets that can go toward the EFC.

Parent-owned and student-owned assets affect FAFSA differently. Parent assets are assessed at 5.64%, whereas student assets are assessed at 20%. For example, if you report $10,000 in parent assets on the FAFSA, your student’s eligible financial aid would decrease by $564, which is 5.64%. However, if the $10,000 is in student-owned account, the eligible aid would decrease by $2,000, which is 20%.

As a result, saving or investing money in student-owned accounts may reduce aid eligibility even more than money in parent-owned accounts. If your primary goal is to pay for college, you might consider whether it makes sense to keep funds in an account owned by them or one owned by you—or in a 529, which is considered a parent-owned account for financial aid purposes (even if your child is the beneficiary).

For some families, the advantages of providing kids with a financial foundation through a UGMA can outweigh the financial aid trade-off, especially if they aren’t positive that their kids will attend college or if they want to save money for other goals, such as a down payment on a future home.

When Student Assets Don’t Hurt Financial Aid

While the FAFSA is important for determining need-based aid, it’s only part of the overall financial aid package your child may receive. Many colleges offer financial aid through scholarships, grants or tuition discounts (sometimes called tuition waivers). Tuition discounts can cut college costs in half. More than a third of undergraduates receive merit-based aid from private, nonprofit, four-year colleges. If your kid is a top student or athlete, a more significant portion of their college costs may come from merit-based aid, and their investments may not reduce those opportunities at all.

You should also consider how likely your student is to be eligible for need-based aid. While there’s no particular income cut-off, you’re not guaranteed federal aid. If your income, assets, family size and other factors indicate that you probably won’t qualify for much aid, you might find it’s more worthwhile to offer your child an account with flexibility rather than trying to optimize the financial aid equation.

It’s also worth noting that neither the value of your retirement accounts nor retirement accounts in your child’s name are included in FAFSA calculations, although IRA withdrawals to pay for college will count as income. If you’re thinking about contributing to your child’s future retirement or using a penalty-free IRA withdrawal for a house down payment, this could be a way to shift funds out of FAFSA calculations. Here's more on UGMAs vs. custodial Roth IRAs.

Investing for Kids While Protecting Student Aid

As college years approach, you may want to review your family’s finances. You may be able to take certain steps to improve your overall aid eligibility. Note as well that new rules came into play for 529 plans in 2024, such as the ability to roll over unused 529 funds into a Roth IRA. Earlier updates made changes such as enabling 529 plans to be used for K-12 education and other qualified expenses. Familiarizing yourself with the newest 529 rules can help you maximize your contributions and all of your possible benefits.

Financial aid is more than a simple calculation. Money in investment accounts can reduce some types of aid, but that’s no reason to panic. Your child’s accounts may not have a major impact on their total financial aid offer, and investing early can have a more powerful effect on potential growth over time. Consider the advantages and trade-offs to find the balance of accounts and priorities that fits your plans for your child.

Fabric by Gerber Life and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.