As FAFSA rules change, more grandparents may save in 529 plans

Bill Cass, CFP®, CPWA®

Bill Cass, CFP®, CPWA®, 05/03/23

Changes are coming soon to the federal financial aid application process that could make it easier for grandparents to help fund their grandchildren’s higher education with a 529 savings plan.

In 2020, Congress passed the Consolidated Appropriations Act, which included several changes to simplify the FAFSA (Free Application for Federal Student Aid) filing process. For example, the Expected Family Contribution (EFC) calculation when determining eligibility for federal aid is being modified and renamed to the Student Aid Index (SAI).

Most of the changes will be implemented for the 2024–2025 award year. The revised FAFSA form will be available in December 2023, according to the Department of Education.

Among the changes is the treatment of 529 savings plans owned by non-parents, such as funding from grandparents. Historically the EFC has not considered 529 plan funds owned by grandparents as part of the “asset test” portion of the calculation. However, funds withdrawn from a grandparent-owned 529 were included in the “income test” portion of the calculation.

Beginning with the 2024 award year, distributions from a non-parent-owned 529 savings account, such as a grandparent-owned 529, will not be counted as income to the student for purposes of the FAFSA test. This could make significant difference as the FAFSA counts 50% of student income toward the calculation of the EFC. Under current rules, a $10,000 distribution from a grandparent-owned 529 may reduce the following aid award by $5,000. It’s important to note that some colleges require students seeking financial aid to complete an additional filing through the College Board known as the CSS Profile. This process may consider 529 assets held by a non-parent like a grandparent as part of the aid calculation.

This change may make it easier for grandparents as they consider helping their grandchildren.

Additional advantages to giving

  • Anyone can contribute to a 529 account.
  • Funding a 529 could be an advantage in estate planning. In certain cases, contributions to the account can be removed from the owner's estate for tax purposes, yet they can generally retain control over the assets. For 2023, the gifting limit per beneficiary is $17,000 annually for individuals and $34,000 for married couples. Annual gifts above these amounts would be considered taxable gifts and would trigger the filing of a gift tax return. However, direct payments to an institution are not considered gifts.
  • Grandparents may choose to fund a large gift up front. A special provision of 529 plans allows contributions equal to five years' worth of gifts to a single beneficiary in a single year without triggering the federal gift tax. The maximum contribution eligible for the 5-year election for individuals/married couples is $85,000/$170,000 for 2023.
  • The account owner pays no federal income tax on earnings or withdrawals if they are used for qualified education expenses.
  • Retirees who are not relying on required distributions from retirement accounts to meet their income needs may want to consider using those withdrawals to fund a 529 plan for grandchildren. While required distributions from traditional retirement accounts are taxable, funds within a 529 can be withdrawn tax free if used for qualified education expenses.

link to learn more about Putnam 529 for America