Use 529’s grandparent loophole to maximize savings for college
Q: Will my contributions to a 529 college savings plan for my grandchild affect her federal financial aid? A:
Not much longer, thanks to changes to the Free Application for Federal Student Aid. The FAFSA Simplification Act, an overhaul of the processes and systems used to award federal student aid, will become finalized in the 2024-25 school year. The simplification, which removed over two-thirds of questions previously asked, lets grandparents with 529 accounts take advantage of what’s called the grandparent loophole.
Previously, distributions from a grandparent’s 529 plan were reported as untaxed student income, which could reduce aid eligibility by up to 50% of the amount of the distribution — a significant penalty. For example, under the old rules, a $10,000 distribution from a 529 plan could reduce your grandchild’s aid eligibility by $5,000.
However, with the new streamlined FAFSA, there’s a difference in how distributions are treated compared to previous years, giving grandparents a positive advantage.
On the 2024-25 FAFSA, students are no longer required to report cash gifts from a grandparent or contributions from a grandparent-owned 529 savings plan. Because of this, grandparents can now use a 529 plan to fund a grandchild’s education without affecting the student’s financial aid eligibility.
In fact, with the new FAFSA form, a student’s total income is only based on data from federal income tax returns via the IRS. Therefore, any cash support, no matter the source, will not have a negative impact on financial aid eligibility on the FAFSA.
Also note that more than 200 private institutions use the CSS Profile for awarding their own financial aid and, with this, grandparent-held 529 plans will still be considered.
Using a 529 plan can be a great way to save for your grandkids’ college education. A 529 plan allows a contributor to prepay a beneficiary’s qualified higher education expenses at an eligible educational institution or to contribute to an account for paying those expenses.
While 529 contributions have to be made with after-tax money, the contributions grow free from federal or state tax. Plus, more than 30 states offer a state income tax deduction to residents contributing to their home-state plan.