Using a 529 plan can be a great way to save for your grandkids’ college education. 529 plans allow 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-federal-tax money, the contributions grow free from federal or state tax. Plus, grandparent-owned 529 plans now have an added benefit, thanks to the FAFSA Simplification Act.
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.”
529 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 $10,000 529 plan distribution could reduce your grandchild’s aid eligibility by $5,000.
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However, with the new streamlined FAFSA, there’s now 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 impacting their 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 negatively impact financial aid eligibility on the FAFSA. However, at over 200 private institutions that use the CSS Profile for awarding their own financial aid, grandparent held 529 plans will still be considered.
Additionally, 529 plans are subject to gift taxes when they exceed certain thresholds. For 2024, the annual gift tax limit is $18,000 or $36,000 for married couples. And this limit applies to each person who is receiving a gift. This means that you can donate up to $18,000 or $36,000 per grandchild each year without owing a federal gift tax.