529 Plans: How to Plan for Merit Aid

By Brett Carolan, CFP® | Feb 23, 2018 |

A short guide on merit aid and why it matters to your college savings strategy

uw campus merit aid

Investing in a 529 college savings plan provides strong financial security for your child’s future college goals. Depending on how early you start saving and how much you’re contributing to the plan each month, you may have saved up enough funds to cover all or most of your child’s education expenses by freshman move-in day.

However, one of the biggest things parents don’t account for when establishing a 529 plan is the potential for merit aid from the college or university. If your child receives some form of merit aid (or any other type of financial aid, for that matter), this could have both a positive and negative impact on the funds sitting in your 529 college fund.

While you can’t predict with 100 percent certainty that your child will be offered merit aid or how much their award will total, it’s important to bake the possibility into your college savings strategy.

529 College Savings Series

Merit Aid: A Brief Overview

The general term “merit aid” refers to grants, scholarships, and other financial rewards offered by a college or university without regard to financial need. In other words, students who don’t qualify for need-based aid can still get a discount on their college costs.

A student’s merit aid might be awarded based on academic record, athletic achievements, special skills such as art or music, or several other criteria. This money typically goes straight to the university for payment of tuition or room and board without any involvement from the student. As an added bonus, many merit aids awards are renewable each year; if the recipient continues to meet eligibility requirements, he or she can continue receiving their award through graduation.

Merit aid shares characteristics with private scholarships, but there are a few notable differences. Cappex notes that private scholarships are generally funded by corporations or businesses, not the university. In addition, they are typically granted on a one-time basis and are non-renewable. The award amounts tend to be lower than merit aid awards and are much more competitive to receive.

Many merit aids awards are renewable; if the recipient continues to meet eligibility requirements, he or she can continue receiving their award through graduation.

Cappex estimates there’s over $13 billion in available merit aid, with $11 billion coming directly from schools and the remaining $2 billion funded by the federal government. Both merit aid and private scholarships can go a long way toward funding your child’s education.

If you want to increase your chances of receiving and retaining merit aid, there are a few best practices you can follow:

  • Apply to schools where your grades are likely to be among the top 20 percent of students. When looking at the strength of their applicant pool, some schools may try to draw in top performers with lucrative merit aid.
  • Pay attention to renewable benchmarks. If you receive potentially recurring merit aid, you’ll need to plan accordingly to give you the best chance of retaining it. For example, if you need to maintain a 3.5 GPA to keep your merit aid, you might take your easiest courses first to give you the best chance of securing your aid longer.
  • Negotiation is your friend. If you receive offers from two universities, don’t be afraid to bargain with each to see which one is willing to offer you more.

However, there’s no guarantee your child will receive merit aid—especially if your child chooses to attend a university that offers no form of merit aid.

The Best and Worst Universities for Merit Aid

While every college and university offers some form of financial assistance, some are more generous with their merit aid than others.

According to U.S. News and World Report data, the 10 colleges offering merit aid to the most students had “more than 40% of full-time students in fall 2015 (receive) merit awards without qualifying for need-based aid.”

Here’s the list:

  • Cooper Union (New York)
  • Rhodes College (Tennessee)
  • Trinity University (Texas)
  • University of Puget Sound (Washington)
  • Hillsdale College (Michigan)
  • Samford University (Alabama)
  • Denison University (Ohio)
  • New School (New York)
  • Gonzaga University (Washington)
  • University of San Francisco (California)

However, if your child has their sights set on an elite college, you’ll be thankful for your 529 college savings plan, if you have one. Some of the nation’s top private schools offer no merit scholarships, including the following:

  • Amherst College (Massachusetts)
  • Brown University (Rhode Island)
  • Cornell University (New York)
  • Dartmouth College (New Hampshire)
  • Harvard University (Massachusetts)
  • Juilliard College (New York)
  • Massachusetts Institute of Technology (MIT) (Massachusetts)
  • Princeton University (New Jersey)
  • Sarah Lawrence College
  • Stanford University
  • Vassar College
  • Wellesley College
  • Yale University

This list isn’t meant to be exhaustive, but it does illustrate that some of the most prestigious schools offer no financial footholds, even for high achievers. You’ll need to be prepared with a different strategy, such as private scholarships, government grants, or funds from your 529 savings plan to cover the costs.

How Do Students Receive Merit Aid?

One of the most attractive features about merit aid is that, in many cases, there’s not much you need to do to receive it. Merit aid requirements vary from school to school, but most of the time you’ll only need to apply and be accepted in order to qualify for most merit aid awards.

Some awards are based on early acceptance, while others may exist specifically for transfer students. This is good news for those who want to go to a community college first, then transfer to a better school once they complete basic coursework or discover what they want to major in.

Other merit aid scholarships will require a bit of work on your part. In some cases, you may need to apply for individual opportunities. Some merit aid scholarships are well advertised by the university, while others will require searching to find.

If you aren’t sure what forms of merit aid are available at a particular university, there’s no harm in asking someone in the college financial department about your options.

However, since merit aid differs among schools, it’s in your best interest to research the opportunities for each school to discover where you’ll receive the biggest financial benefit.

Understanding your child’s merit aid potential can give you a better idea of your estimated family contribution (EFC) to help you adjust your college savings strategy, if necessary.

uw campus aerial merit aid

Merit Aid Isn’t Without Its Pitfalls

If your child has good grades or is gifted in a particular area, such as playing soccer or the violin, he or she may be awarded some form of merit aid, depending on the university. At first glance, it looks like good news, and to many families who may not otherwise be able to send their child to college, it is. However, there are a few pitfalls to be aware of so you don’t worsen your financial situation.

529 College Savings Plan Overflow

If your child’s university awards, say, $4,000 a year in merit aid, that’s $4,000 you don’t have to pay. But what happens to all that money you’re stashing away in the 529 savings plan?

The rules say the money in a 529 plan must be used to pay for education expenses, such as tuition, university fees, books, and room and board. Tuition is often the largest of those expenses, and if the university is paying all or most of that amount, you may find it difficult to use what you’ve saved in your 529.

If you use the money for something other than educational expenses, you could face a 10 percent penalty on those funds in addition to federal income tax on your earnings.

There are a few ways to avoid this situation:

  • Transfer the 529 funds to another beneficiary. You face zero tax consequences for rolling over your money to another child, whether it’s your own or, say, a niece or nephew.
  • Use the funds for future educational needs. Your child doesn’t have to attend a four-year college to use 529 funds. If they decide to attend a vocational school or technical college, you can use the money to pay their way. In addition, they may later decide to attend graduate school or another educational program, in which case they’ll appreciate the extra financial cushion.
  • Leverage the no-penalty withdrawal option. If your child receives merit aid or another scholarship, you have the flexibility to withdraw up to that amount without facing the 10 percent tax penalty. The only fee you’ll pay is income tax on any earnings.

Either way, $4,000 worth of merit aid (or however much your child receives) is still $4,000 you don’t have to pay or borrow. Still, the bite of knowing you “over-saved” and didn’t invest that money elsewhere can sting.

Scholarship Displacement

There’s a growing uproar over colleges and universities that practice scholarship displacement. In fact, Maryland became the first state to banish it from their schools.

Simply put, scholarship displacement allows the school to lower or eliminate a student’s need-based awards based on their private scholarship awards.

For example, if your tuition costs for a year are $30,000, and you receive a merit-based award for $15,000 and a need-based grant for $5,000, then discover you’ve won a $5,000 scholarship from a private scholarship, your need-based grant may be reduced or revoked. The reasoning here is that you no longer have the same “need” for the $5,000 that you did before you won the private scholarship of the same amount.

Starting a 529 college savings plan can provide a backup plan in case your child encounters a scholarship displacement situation.

Some experts argue that this practice reduces or eliminates incentives for hard-working students to earn scholarships. In the end, the net of their effort is zero.

Maryland’s new law states that a student’s award can change in two circumstances:

  • The student’s total award package is greater than the cost of attendance; or
  • The student’s scholarship provider gives permission to change the award amount.

While scholarship displacement doesn’t really affect your school-issued merit aid award, it’s important to understand its impact on your child’s total college cost. If you haven’t invested in a 529 savings plan and are banking on merit aid, private scholarships, and need-based awards, like the Pell Grant, you may find your awards package falling short because of scholarship displacement. Starting a 529 college savings plan can provide a backup plan in case your child encounters a scholarship displacement situation.


Unless your student has already been accepted into college and has been awarded a merit-based scholarship, there’s no way to be certain what forms of financial aid your child will receive. What is certain is that the funds you contribute to a 529 college savings plan can help fill in gaps in their award package, merit-based or otherwise.

Talk to one of our experts today, and together, we can help you tailor a college savings strategy that fits your unique circumstances.

Read other posts in our 529 College Savings series:

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