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Grandparents and Advisors Need to Know About These 529, FAFSA Changes

·4 min read
This image shows grandparents and a student. Grandparents should know about new FAFSA changes that will impact 529 college savings accounts.
This image shows grandparents and a student. Grandparents should know about new FAFSA changes that will impact 529 college savings accounts.

State and federal tax benefits make a 529 college savings account one of the more strategic ways to save money for college. But savers should be aware: Upcoming changes to the Free Application for Federal Student Aid (FAFSA) may create a new financial planning opportunity for grandparents (and any nonparent family members and friends) who want to help a student save for college. The changes could impact 2022 tax year student income. Here's what grandparents, financial advisors, students and investors should know.

A financial advisor can help you plan and save for your child's college education. Find a trusted fiduciary advisor today.

What Is a 529 College Savings Account?

This image shows a student. Changes to the FAFSA will impact nonparental 529 college savings accounts.
This image shows a student. Changes to the FAFSA will impact nonparental 529 college savings accounts.

A 529 account is a tax-advantaged investment account designated for certain college and educational expenses. It's named for section 529 of the tax code and offers tax-deferred investment growth and tax-free withdrawals made for qualified educational expenses. Additionally, 529 accounts may carry state tax benefits.

For grandparents (and other nonparent savers), 529s can create a great gifting and estate-planning tool. Investors may squirrel away up to $16,000 per individual in 2022 without running into any gift-tax complications. One estate-planning strategy is to "superfund," or deposit a large lump sum in the account, and treat it as if it were split up over five years. For example, a grandparent's one-time deposit of $80,000 could be treated as five annual investments of $16,000.

How Does the FAFSA Account for Grandparent 529s?

This image shows a grandfather walking on the beach with his grandson. New FAFSA and 529 rules impact grandparent college savings accounts.
This image shows a grandfather walking on the beach with his grandson. New FAFSA and 529 rules impact grandparent college savings accounts.

The Free Application for Federal Student Aid (FAFSA) is the form used by students and their parents to apply for federal financial aid. It can determine eligibility for grants, work-study placements and student loans.

One challenge grandparents with 529s face is how the FAFSA tallies student withdrawals from their accounts.

Currently, the federal aid formula treats the distributions from a nonparental 529 plan, such as one owned by a grandparent, as untaxed student income, which could reduce a student's aid eligibility by up to 50% of the amount. To dodge this, grandparents have had to get clever with 529s. Some have the student tap the account only during the last two years of college, for example, in order to not have the funds count against need-based financial aid.

New Rules 529 Rules Grandparents and Advisors Should Know

Recently, Congress approved changes to the FAFSA. New federal legislation plans to nix a question about cash support. That means grandparent-owned 529s wouldn't impact financial aid eligibility. This change has been delayed once already. But experts anticipate that it will take effect for the 2024-2025 school year.

Because the FAFSA looks back two years, 529 withdrawals taken by a student in 2022 from a grandparent account may not impact need-based aid eligibility for the 2024-2025 school year. This is great news for grandparents and other nonparent relatives and friends who want to help a student save for college. Going forward, the student will have more leeway to use those gifted funds without running into financial aid challenges down the road.

Bottom Line

For years, savvy grandparents (and other nonparent family members and friends) have used 529 accounts to save for educational expenses. But these savers have had to eye one drawback: The way the government viewed distributions from a nonparental 529 account could seriously impact the student's eligibility for financial aid in subsequent years.

That's likely to change in the 2024-2025 school year thanks to an overhaul of the FAFSA.

Tips for Saving with a 529 Plan

  • With so many 529 plans to choose from, a financial advisor can help you pick a plan that suits your needs and financial situation. Finding a qualified financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.

  • When selecting a 529 plan, be sure to look outside of your home state's plan(s). To help you see what's out there, SmartAsset has compiled information on a majority of states' plans. Use our map to navigate between individual states and the plans they offer.

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Photo credit: ©iStock.com/Halfpoint, ©iStock.com/kupicoo, ©iStock.com/jacoblund

The post Grandparents and Advisors Need to Know About These 529, FAFSA Changes appeared first on SmartAsset Blog.