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What the FAFSA Changes Mean for Grandparents

What the FAFSA Changes Mean for Grandparents

For grandparents who want to leave a legacy to their grandchildren, the gift of a 529 college savings plan is an option. Not only can opening a 529 plan account help a grandchild with educational expenses, it can also help grandparents with their estate planning goals.

In the past, grandparent 529 plans had the potential to reduce student aid eligibility. However, changes to student aid application rules mean that soon, 529 distributions from grandparents will not count toward a student’s income on the most-used financial aid form. This is welcome news for grandparents!

Grandparents may contribute to a 529 plan that has already been established by the parents, or they can open a separate plan. Until recently, there was a major disincentive for grandparents to open their own 529 plan because students had to report the funds as untaxed income on their FAFSA form. As a result, the income from a grandparent-owned 529 plan could reduce the amount of financial aid the student qualified for. The same was true of parent-owned 529 plans, but the maximum reduction amount was significantly lower than the one from grandparent-owned plans.

The FAFSA Simplification Act, signed into law in late 2020, made several changes to the FAFSA form. One of the changes is that students will no longer have to disclose cash support on their FAFSA form.

The upshot for grandparents is that they no longer have to worry about the financial aid trap previously associated with grandparent-owned 529 accounts. They can use a 529 account to help pay for their grandchild’s education without concerns that it will harm financial aid eligibility.

Importantly, income reporting changes are not yet in effect. Until they are, money from grandparent 529 plans may count as untaxed income on a student’s FAFSA form. The Department of Education announced in the summer of 2021 that full implementation of FAFSA changes, originally scheduled for the 2023–24 school year, will be delayed until the 2024–25 school year.

This delay should not affect plans to fund a grandchild’s education, because the funds in a grandparent-owned 529 plan come into play only when they are released. Therefore, grandparents can continue to put money into a 529 plan without affecting student aid eligibility. They will want to pay attention to when the new FAFSA rules take effect.

Leaving a legacy in the form of education funding is its own reward, but 529 plans provide financial benefits to both grandkids and grandparents, including the following:

  • Investment earnings and withdrawals from a 529 plan are tax-free if they go towards qualified educational expenses.
  • The money from a 529 plan can be used for non–education-related expenses. The money withdrawn is subject to a 10 percent penalty and taxes on the investment gain but the money can be tapped in an emergency.
  • If the grandchild decides not to attend college, the grandparent owner can change the beneficiary. In fact, the beneficiary and the ownership can be changed at any time.
  • Contributions to a 529 plan are removed from the owner’s taxable estate, lowering estate tax liability.
  • While 529 contributions are considered gifts to the beneficiary and could be subject to the federal gift (and generation-skipping transfer) tax, this tax can be avoided by spreading a lump-sum contribution over a five-year period, a strategy known as “superfunding” a 529 plan.
  • State rules vary for 529 plans, including contribution limits, but you can pick a plan from any state. You are not limited to plans in the state where you live, and students can use the money to attend a qualified school in any state.

It is important to remember that anytime you are dealing with the Internal Revenue Service, there are myriad rules and regulations that must be met, and 529 plans are no exception. State rules also apply to 529 plans. To get the most out of your plan, make sure you work with a knowledgeable professional. To learn more about ways you can help the next generation with their education and help yourself with a proper estate plan, call us at (405) 928-4075.