This thing bothers me -- in part because it makes no sense, and in part because it means that people like me should not be investing in 529 plans. However, I found this statement in the information packet for Massaschusetts' U Plan. It seems both clear and logical. They refer to a DOE ruling (8/24/99) which indicates that "when the earnings portion of a distribution from an Account is included in the taxable income of the Beneficiary (for distributions used for the Beneficiary's qualified higher education expenses after December 31, 2010) or in the taxable income of the Participant (for all other distributions), the increase in taxable income could affect EFC in the subsequent year. Specifically, the earnings portion of the distribution could be applied to the EFC either as student income, parent income or spouse income (as the case may be)."
To me, this says that as long as you are using your 529 plan only for qualified higher education expenses, it counts as a parental asset, and there is no income involved. After all, these plans were designed as tax free college savings plans. If you use it for some other reason, the earnings portion (but presumably not your original investment amount) becomes income to the participant (parent) and would impact the EFC. That strikes me as entirely appropriate. The only way it would be counted as income to the Beneficiary (child) would be in the year 2010 and beyond if Congress allows the law to expire. That is a long way off, but I would be mighty surprised if Congress would do away with a benefit like this.
So, am I misreading something, or have there been new rulings, or is Fidelity -- which sponsors the U Plan -- being less than forthcoming?