In the past, grandparents may have hesitated to leave their grandchildren a gift of a 529 college savings plan because it had the potential to reduce student aid eligibility. Good news! Recent changes to the Free Application for Federal Student Aid (FAFSA) forms mean that distributions from grandparent-owned 529 plans will not count towards a student’s income on the commonly used FAFSA form.
This change to the FAFSA form is welcome news for grandparents who want their legacy to be helping their grandchildren cover the ever-increasing costs of higher education without affecting whether their grandchildren qualify for need-based financial aid.
Student loan debt in the United States has reached $1.762 trillion. The rise in total debt accumulation has slowed, but the average debt per borrower is increasing.
Only mortgages are higher than student loans in the consumer debt categories. Students in private, non-profit universities borrow an average of $33,900, while students in private for-profit universities borrow $43,900.
Public university attendees pay an average of $30,030 to earn a bachelor’s degree. The growth rate of student loans outpaces the rise in tuition costs by 353.8%.
How a 529 Plan Can Help
One of the most popular ways to save for education is a 529 plan. Students graduating with lower debt have more potential opportunities than students saddled with large educational loans.
These plans are named after Section 529 of the Internal Revenue Code and are maintained at the state level. Nearly every state has a 529 plan. Wyoming is the exception.
How Grandparents can Contribute to 529 Plans
Grandparents can contribute to 529 plans established by parents, or they can open a separate plan.
Parent-owned 529 plans are listed on the FAFSA as parental assets, which are counted at a rate of 5.64% available to pay for education expenses.
Before the anticipated FAFSA changes come into effect, grandparent-owned 529 plans are not listed on the FAFSA.
This means that any withdrawals from a grandparent-owned 529 plan are counted as untaxed student income.
As a result, income from a grandparent-owned 529 plan can reduce the amount of financial aid a student qualifies for.
Both parent-owned and grandparent-owned 529 plans can reduce need-based financial aid, but the impact is much less than the parent-owned 529 plan.
FAFSA Changes that Impact Grandparent-Owned 529 Plans
The FAFSA Simplification Act, signed into law in 2020, made a significant change to the FAFSA form.
As a result, students will no longer need to disclose cash support on their FAFSA form.
This means that grandparents can use a 529 account to help support their grandchildren’s education without concerns that this support will reduce their need-based financial aid eligibility.
This change is not yet in effect. The Department of Education announced that the changes originally scheduled for the 2023-2024 school year will be delayed until the 2024-2025 school year.
Grandparents can fund 529 plans now without impacting financial aid eligibility. When the funds are withdrawn, not when they are deposited, is what is important.
Grandparents with grandchildren entering college in the next few years may want to keep a close eye on when these changes come into effect.
They should also be aware that grandparent-owned 529 plans will still be considered on the College Scholarship Service Profile.
A small number of private colleges use this form.
Advantages of the 529 Savings Plan
In addition to funding tuition, there are many other benefits and advantages of using a 529 Savings Plan:
- Funding can be used for books, supplies, equipment, software, and internet access.
- Students living off-campus can use 529 funds to pay for rent, utilities, and food.
- 529 funds can be used to pay for primary and secondary school tuition.
- Investment and withdrawals from a 529 plan are tax-free as long as they are used to pay for qualified educational expenses.
- 529 money can be used to pay for other expenses in an emergency but is subject to a 10% penalty and taxes on the investment gain.
- Both the beneficiary and the owner of a 529 plan can be changed at any time.
- Contributions to a 529 plan lower the owner’s taxable estate, which lowers estate tax liability.
- To avoid federal gift and generation-skipping transfer taxes (529 contributions are considered gifts to the beneficiary), a lump sum to a 529 plan can be spread over five years, a practice known as superfunding a 529 plan.
- Some states offer a tax break for funding a 529 plan.
- You can shop for 529 plans from any state. You are not limited to the state you live in, and the funds can be used to finance education in any state, as long as it is a qualified school.
There are many rules associated with 529 plans, including rules from the states and the Internal Revenue Service.
To get the most out of your 529 plan and use it as part of a comprehensive estate plan, contact us to learn more about how we can help you with your estate planning.