The New FAFSA and Grandparent Owned 529 Plans

As the price of college tuition continues to rise, families have become increasingly focused on finding effective ways to fund the education of future generations. For grandparents looking to help fund college costs for their grandchildren, 529 plans previously came with the burden of potentially impacting the student’s need-based financial aid. However, with recent FAFSA (Free Application for Federal Student Aid) changes, grandparents can now utilize 529 plans without hindering their grandchild’s ability to receive FAFSA based financial aid awards.

A 529 plan is a tax-advantaged savings vehicle designed to help families save for future education expenses. 529 plans can be opened by anyone (parents, grandparents, aunts and uncles, etc.) and are funded with after-tax contributions. The investment earnings inside of a 529 plan account are tax-deferred and withdrawals from the account are tax-free, if used for qualified education expenses. These qualifying expenses include tuition and fees, books, supplies, computers, and computer equipment. Room and board are also considered qualified expenses as long as the student is enrolled at least half-time.

You can contribute up to $18,000 per year ($36,000 for married couples) to a 529 plan for each beneficiary without triggering any gift tax consequences. 529 plans also allow you to front-load up to 5 years of annual contributions. This means you can contribute a lump-sum of up to $90,000 ($180,000 for married couples) to a 529 plan for each beneficiary without facing gift tax consequences. Please note, if you front load 5 years of contributions to a 529 plan, any other gifts made to the grandchild during the next five-year years would be considered a taxable gift for gift and estate tax purposes. Additionally, each state imposes an aggregate limit to the amount of funds a student can have in one or more 529 plans before contributions are no longer allowed. Currently, this ranges from $235K to over $500K in certain states.

Historically, when grandparents distributed funds from 529 plan accounts to help pay for their grandchildren’s college expenses, it had the potential to negatively impact the grandchild’s need based financial aid eligibility. Although grandparent-owned 529 plans were not considered the student’s assets, the distributions were treated as the student’s income on future FAFSA filings. This income counted heavily against the grandchild’s need-based financial aid award with the potential to reduce the award by up to half of the income received.

To sidestep this issue, grandparents were often advised to delay 529 plan withdrawals until their grandchild’s final two years of college. Delaying withdrawals helped keep the grandparent owned 529 plan funds from being considered income for the FAFSA since each FAFSA filing looks at the parent’s and student’s tax returns from two years prior. For example, if a grandparent paid for their grandchild’s first-year tuition from a 529 plan, that income would later be recognized on the student’s FAFSA heading into their third year of college. But, if the grandparent waited to make distributions until the student’s third year of college, the distributions would likely never be reflected on the student’s FAFSA filings, since the student’s final FAFSA filing would only include tax information from two years prior (i.e., the student’s second year).

Beginning with the 2024-2025 academic year, the FAFSA no longer asks questions related to grandparent-owned 529 plans. That means distributions will not be considered income to the student going forward. Under these new rules, grandparents can now fund qualified education expenses from their 529 plans starting in the grandchild’s first year of college without impacting the student’s FAFSA. It’s worth noting, however, that over 200 colleges use a different methodology, known as the CSS profile. Unlike the FAFSA, the CSS profile still factors in grandparent owned 529 plans when calculating institutional based financial aid awards. Therefore, it is important to know the financial aid methodology each grandchild’s school uses before making any distributions.

Grandparents interested in opening 529 plans for their grandchildren should keep several things in mind.

• You are not required to use your state’s 529 plan. Most 529 plans allow non-residents to open accounts. However, many states offer tax benefits to residents using their state’s 529 plan.
• Opening a 529 plan in a specific state doesn’t mean the funds have to be used in that state. Instead, 529 plan assets can be spent on qualified education expenses in any state.
• Only one beneficiary can be named to a 529 plan at a time. If you are looking to save money for multiple grandchildren, consider opening a 529 plan for each grandchild.
• Grandparents should talk to their children before opening a 529 plan. This will help parents and grandparents better coordinate college funding for the student and avoid overfunding future college expenses. Additionally, having this discussion early on can give grandparents flexibility to determine which grandchildren will need more support due to them receiving less financial aid and/or parental support.

Utilizing a 529 plan is a highly effective and tax-friendly way to fund a grandchild’s college education expenses. With the updates to the FAFSA, now is the best time to review your college funding strategy for your grandchildren. If you are considering setting up a 529 plan, already have one established, or have questions surrounding future college expenses, please see our fact sheet on College Education Savings or discuss with your Aldrich Wealth financial advisor.