• Brenden Leese, CFP®

Students Now Less Likely To Be Penalized for Grandparent 529s

Updated: Oct 27

Key Takeaways

  • New FAFSA form no longer counts grandparent 529 accounts against student aid eligibility.

  • 529 plans offer grandparents several advantages, including many gifting and estate planning benefits.

  • If both parents and grandparents can contribute, consider using the grandparent account for the early years of college to give parents and students more time to save.

As discussed in last month’s post (National 529 Day Should be All Year Round), 529 plans are one of the most effective ways for parents and grandparents to help pay for higher education. Even better, changes have been made to the widely used Free Application for Federal Student Aid (FAFSA) form so that contributions made by grandparents to a student’s 529 college savings account no longer count against aid qualification.


Funds held in a parent-owned 529 plan are still listed as a parental asset. Only the first $10,000 in 529 plan funds held by parents will fall under the Asset Protection Allowance. Any assets above $10,000 can reduce a student's aid package by up to 5.64% of the asset's value. 


Until recently, 529 plans owned by grandparents were treated differently. Funds held by grandparents did not need to be listed on the FAFSA form, but any withdrawals from those funds used for college expenses had to be listed as “untaxed student income” in the following year. This reduced student aid eligibility by up to 50%. 


Fortunately, new changes to the simplified FAFSA form mean that students will no longer  be required to report any cash support they receive, including funds from grandparent-held 529 accounts, in the future. So, funds in grandparent 529 plans won't be counted when the FAFSA is filled out OR when distributions are made to cover eligible college expenses. This is a big win for grandparents who want to help cover the high cost of higher education, as well as for families who don’t want their student to miss out on financial aid due to grandparents saving on their behalf.

Just remember this new rule applies only to the majority of colleges and universities that use the FAFSA form to determine financial aid. As some of you know, the more burdensome CSS Profile used by many highly selective private institutions still counts grandparent 529s against a student’s aid eligibility. That’s important because 529s can be used not only to pay for tuition, but for the ever-rising cost of room and board, books and supplies, college-required computers and internet access. 


529 plans offer grandparents several advantages, including many gifting and estate planning benefits. Since grandparents are usually in their peak earning years or already retired, they’re often thinking about their financial legacy. For grandparents, the IRS looks favorably on 529s in many ways:

  • Contributions to 529 plans are considered completed gifts and are removed from the contributor/owner’s taxable estate, but the owner maintains control.

  • A grandparent can make a single five-year lump sum contribution of $80,000 (5 x $16,000) to a 529 account all at once (Double that if both choose to do it) – and it’s free of gift tax. This can be done for as many beneficiaries as the contributor desires.

  • Access to tax-deferral with no time, age or income limits and with no required minimum distribution from 529 accounts for the owner or successor owner upon inheritance.

529s are also very flexible for grandparents. If the beneficiary decides not to attend college, the account owner can easily change the beneficiary at any time. Equally important is the account owner’s ability to transfer ownership. Grandparents can maintain control while the beneficiary is still years away from college. If grandparents unexpectedly need the account assets for their own use, then can transfer ownership to the beneficiary’s parent when it’s time to take distributions for college expenses. 

The other reason I’m encouraged by this FAFSA change is that families can now use the grandparent 529 first to pay for the early years of college (say freshman and sophomore year), and not have to tap the parent 529 and/or student’s savings until the later years of college. This gives parents and students several extra years to continue saving (and compounding) for higher education.

At Novi, we take education very seriously. We can run various college saving scenarios based on savings capacity/desires and help you fund the accounts appropriately – at no charge. We can also help you decide which vehicle makes the most sense for you.

Conclusion

If you or someone close to you has concerns about their college savings plans, please don’t hesitate to reach out. We have helped many clients in the same situation. For more about college savings strategies, see my post Are You Taking Full Advantage of Your 529 Plan?

 

BRENDEN LEESE, CFP® is an Associate Wealth Advisor at Novi Wealth Partners