The FAFSA Simplification Act has introduced a significant policy change that benefits families using 529 college savings plans, especially those involving contributions from grandparents. Since the 2024–2025 academic year, distributions from grandparent-owned 529 plans are no longer counted as untaxed student income on the Free Application for Federal Student Aid (FAFSA). In practical terms, a withdrawal from a 529 plan owned by a grandparent will not reduce a student’s eligibility for need-based financial aid under the new FAFSA rules. This seemingly small rule change removes a major deterrent that previously discouraged generous grandparents from contributing to education funding for fear of jeopardizing their grandchild’s financial aid.
Grandparent 529 Contributions Under Old FAFSA Rules
Under the FAFSA rules prior to 2024–25, any money a grandparent (or other non-parent) contributed toward a student’s college expenses could inadvertently hurt that student’s financial aid package. Grandparent-owned 529 accounts were not reported as parent or student assets on the FAFSA (unlike parent-owned 529s, which are reported as a parental asset). On the surface this made it seem advantageous for a grandparent to hold the college savings. However, there was a catch: when the grandparent actually paid out 529 funds for the student’s education, those distributions had to be reported as untaxed income to the student on the FAFSA. Student income (even “untaxed” income like a gift) is heavily penalized in federal aid formulas and can reduce need-based aid eligibility by as much as 50% of the income received.
This treatment amounted to a significant penalty. For example, under the old FAFSA formula a $10,000 distribution from a grandparent’s 529 plan could reduce the grandchild’s need-based aid eligibility by around $5,000. In essence, up to half of the gift’s value was effectively wiped out in lost aid. A well-intended, generous gift from Grandma or Grandpa could therefore backfire by shrinking the student’s grants or subsidized loans. Understandably, this rule became a major deterrent for grandparents from opening 529 plans since distributions could severely impact financial aid. Some workarounds emerged. For instance, families would delay using grandparent 529 funds until the student’s last two years of college (when no future FAFSA would be filed counting that income), or grandparents would transfer the 529 account to the parent’s name, but these strategies added complexity and weren’t always feasible. The bottom line is that under the old rules, the financial aid “tax” on grandparent contributions often discouraged what would otherwise be a generous act of support.
The FAFSA Simplification Act: New Rules (2024–25 Onward)
The FAFSA Simplification Act, passed as part of a recent federal law, overhauled the student aid application process starting with the 2024–2025 school year. While the tumultuous initial rollout was highly publicized, the changes streamlined the form with far fewer questions and included a fix for the grandparent contribution problem. Students are no longer required to report cash support or 529 plan distributions from grandparents (or any non-parent). In other words, the FAFSA no longer counts grandparent-paid college money as student income. The specific FAFSA question that used to capture “money received or paid on your behalf,” which was the trap that caught grandparent 529 distributions, has been eliminated. Now, the FAFSA’s income reporting is drawn primarily from the student’s and parents’ tax return data, and it excludes outside cash support.
What does this mean in practice? It means a grandparent can send money from a 529 plan (or even write a check directly to the college) to help a grandchild pay for tuition, and the student’s federal aid eligibility will remain unchanged. The $10,000 gift in the earlier example would now have no effect on the FAFSA calculation of need-based aid. This change applies not only to 529 college savings plans but generally to any cash support from non-custodial family members.
It’s worth noting that this change affects federal financial aid and many state or college aid programs that rely on the FAFSA. However, families should be aware of a caveat: some private colleges use a separate form called the CSS Profile (for their own institutional aid), which still asks about contributions from grandparents and other third parties. In other words, grandparent 529 distributions might still count against need-based aid at certain private institutions even though the FAFSA ignores them. Financial advisors should check whether a client’s target colleges use the CSS Profile and factor that into planning. Nonetheless, for the vast majority of schools (and all federal aid), the FAFSA Simplification Act’s new rule is a game-changer.
Multi-Generational Wealth Planning Opportunities
With the policy barrier removed, grandparent-owned 529 plans become an even more powerful tool for multi-generational wealth planning and legacy giving. These college savings accounts have long offered attractive tax and estate planning benefits for the contributor, and now the family can enjoy those benefits without the former financial aid trade-off. Here are several strategic opportunities and considerations for financial advisors and families in light of the new rules:
Leverage 529s for Tax-Efficient Wealth Transfer: Contributions to a 529 plan are considered gifts to the beneficiary, which means grandparents can use the annual gift tax exclusion to move money out of their estate in a tax-efficient manner. The annual exclusion amount is $19,000 per beneficiary in 2025, or double that per couple, which can be given gift-tax free each year. Even larger contributions are possible by using the special 5-year gift averaging rule (for example, a grandparent could front-load up to five years’ worth of gifts at once). By funding 529 accounts for grandchildren, grandparents reduce the size of their taxable estate while earmarking assets for a loved one’s education. All the while, the money in the 529 grows tax-deferred and can be withdrawn tax-free for qualified education expenses. Many states even offer state income tax deductions or credits for 529 contributions, adding another incentive for grandparents to contribute locally.
Maintain Control and Flexibility: One key advantage of a 529 plan is that the account owner retains control of the assets. A grandparent who opens a 529 for a grandchild remains the owner and can determine the timing and amount of distributions. If the grandchild’s plans change (say, they receive a full scholarship or don’t attend college), the grandparent can change the beneficiary to another family member or even withdraw the funds (with tax and penalty on earnings) for other purposes. Recent enhancements have increased 529 plan flexibility even further. For instance, a portion of unused 529 funds can now be rolled over to a Roth IRA for the beneficiary after 15 years (up to a lifetime maximum of $35,000, under certain conditions), providing a back-up use for surplus college savings. This flexibility means grandparents can confidently contribute, knowing they won’t “lose” the money if circumstances shift.
Educational Legacy and Values: Funding education is a meaningful way to leave a legacy. By using a 529 plan, grandparents create a dedicated education fund that symbolizes their commitment to their grandchild’s future. Now that their contributions won’t undermine financial aid, grandparents can take pride in fully maximizing that fund. The FAFSA Simplification Act explicitly encourages this kind of family support by removing the penalty, effectively acknowledging that helping a grandchild through college should not be discouraged by aid formulas. Grandparents who might have otherwise held back can be more directly engaged, strengthening family bonds and shared investment in the student’s success.
Conclusion: A New Era for Grandparent College Funding
The FAFSA Simplification Act’s change to 529 plan reporting is a game-changer for college funding strategies. For financial advisors, this is an opportunity to revisit college planning recommendations with multi-generational families. Grandparent-owned 529 plans can now be featured prominently in funding plans, combining their well-known tax advantages with the new freedom from financial aid concerns.
