529 plans are a popular way for grandparents to save for college and for good reason. With a 529 plan, you can build an educational legacy for your grandchild while taking advantage of tax and estate planning benefits. Best of all, under the new FAFSA (Free Application for Federal Student Aid), which goes into effect starting with the 2024-2025 academic year, 529 accounts owned by grandparents will no longer have an adverse effect on a grandchild’s financial aid eligibility.
Under prior FAFSA rules, grandparent-owned 529 plans could have a negative impact on financial aid eligibility for the beneficiary. However, thanks to new rules under the simplified FAFSA, grandparents no longer have to worry about the “financial aid trap.”
Two-thirds of questions have been removed from the new FAFSA, including one that asks about cash gifts from grandparents, said Shannon Vasconcelos, director of college finance at Bright Horizons College Coach.
The new, simplified FAFSA went live in December 2023 for the 2024-25 academic year.
Grandparent 529 Plans Under Prior FAFSA Rules
Overall, 529 plans have a minimal effect on financial aid. Parent-owned 529 plan assets are reported on the FAFSA as parent assets. Parent assets can only reduce aid eligibility by a maximum of 5.64% of the account value. On the other hand, grandparent-owned 529 plans were not reported as assets on the prior FAFSA at all, which would seem to have made them more attractive.
However, the difference came in how distributions were treated under the prior FAFSA rules. While the old FAFSA ignored distributions from a parent-owned 529 plan, distributions from grandparent-owned 529 plans were reported as untaxed student income. Untaxed income to a student can reduce aid eligibility by as much as 50% of the amount of cash support. For example, taking a $10,000 529 plan distribution to help pay for college could reduce your grandchild’s aid eligibility by $5,000 under the previous rules.
This is why it’s such a big deal that the rules are changing. Now, a grandparent will be able to open a 529 plan for their grandchildren and help them pay for college without hurting their financial aid eligibility.
Changes to Grandparent 529 Plan Rules
The updated FAFSA does not require students to report cash support manually. That means a grandparent-owned 529 plan will not have any impact on need-based financial aid eligibility. Some have now referred to this as the “grandparent loophole.”
With the new form, the amount of a student’s “total income,” which includes untaxed income, will come directly from federal income tax returns via the IRS Data Retrieval Tool (DRT). So, a student’s total income amount will only consist of data that comes from the federal income tax return.
Note that this provision applies to any cash support for the student, regardless of the source, so other family members and loved ones can provide financial support without impacting financial aid.
How FAFSA Changes Affect Grandparent 529 Plans
Grandparent 529 Plan Assets
Grandparent 529 Plan Distributions
Old FAFSA Rules
Reported as untaxed student income, 50% of the gift is counted as available funds for college
New FAFSA Rules
Keep in mind, however, that grandparent 529 plans will still be considered on the CSS Profile. The CSS Profile is an additional financial aid form used by about 200 private colleges to award their institutional aid.
It’s still unclear how the upcoming FAFSA changes will affect the CSS Profile and institutional aid eligibility at other schools. Vasconcelos says cash support from grandparents will likely still have an impact.
“It is also possible that with the reduction of questions on the FAFSA, more colleges that are interested in collecting information that is no longer available on the FAFSA will begin to require the Profile or their own institutional application,” she said.
529 Plan Tax Benefits for Grandparents
529 plans offer tax-deferred investment growth, and distributions are tax-free when used to pay for qualified education expenses. With these tax savings, you can build a substantial college fund for a grandchild without having to worry about the money hurting any of their financial plans.
You may also be eligible for additional state tax benefits, depending on where you live and which plan you use. Over 30 states allow residents to claim a state income tax deduction or credit for contributions to a 529 plan. Most of these states only offer tax benefits when you use your home state’s plan. Check your state’s rules to see if you qualify.
529 Plan Estate Planning Benefits
Some financial professionals advise grandparents to contribute to a 529 plan as part of an estate planning strategy. In most cases, you have to consider the Generation Skipping Transfer Tax (GST) when leaving an inheritance to a grandchild. But, 529 plan contributions up to $18,000 per beneficiary qualify for the annual gift tax exclusion in the 2024 tax year. This means married grandparents who contribute $36,000 to a grandchild in 2024 would not include the amount in their taxable estate.
529 plan contributions above the annual gift tax limit will count against your GST lifetime exemption. In 2024, the GST tax exemption is the same as the lifetime gift tax exemption ($13.61 million).
You can shelter an even larger gift if you elect to spread a lump-sum contribution between $18,000 and $90,000 over a five-year period. This strategy is called superfunding a 529 plan.
When you save for a grandchild in a 529 plan, you retain control of the assets over the life of the account, even though you removed the value from your estate. However, you will have to add the value back to your taxable estate if you revoke the gift from the beneficiary.
The Bottom Line
With the new FAFSA changes in place, it’s an ideal time to set up a 529 plan for a grandchild who isn’t currently in school. You can start accumulating assets for them that won’t hurt their financial aid ability when they enroll. See our best 529 plans available in your state.
A 529 plan is a smart investment that can set your grandchild up for future success. 529 plans already offer numerous benefits for grandparents, and the new financial aid treatment makes them even more attractive. But, the financial aid process can change dramatically at any time, Vasconcelos warns.
“When it comes to preparing over 18 years for college payments, the best you can do is to plan based upon the information available to you at the time, but know that there is no guarantee that the rules in effect when you start saving for college will remain in effect when the time comes to pay for college,” she says. “The more you save, however, the better prepared you will be for whatever shifts in policy and priorities occur.”
Frequently Asked Questions (FAQs)
Is it better for a grandparent or parent to own a 529 plan?
Many advisors will push people to have the parent own the 529 plan because recent rules have grandparent contributions hurting total financial aid eligibility. While this will change with the new FAFSA, many private colleges still will use the CSS system, so in those cases, there could still be a negative impact to the student if the grandparent owns the account.
Can grandparents write off 529 plan contributions?
More than 30 states offer a state income tax deduction to grandparents who contribute to a 529 account. They may still qualify for this deduction if someone else owns that 529 account. The amount and eligibility will depend on the state where the grandparent resides.
How much can a grandparent contribute to a 529 plan?
There is no individual limit to how much you can contribute to a 529 plan in a year. Every account has a lifetime limit of primary contributions that it can receive, and it varies based on who administers the account. It typically varies between $350,000 to more than $500,000 and doesn’t include any growth accumulation.
The grandparent might trigger certain gift tax rules, though, if they give too much to a single account or beneficiary during the course of a single year.