The Grandparent Loophole: 529 Plans Revisited
My October Insight 529 Plans: Unsung Heroes of Financial Planning sang the praises of the usefulness, utility, versatility, and underrated value of 529 plans as financial planning tools.
One key takeaway is that 529 plans are often useful even if you don’t have college-bound children. If you’re a grandparent considering starting a 529 plan, you should be aware of the recent revisions to the Free Application for Federal Student Aid (FAFSA) that went into effect as of the 2024-2025 academic year.
As you may know, the detailed and lengthy FAFSA is used by the federal government to calculate financial aid packages for college and university students. The U.S. Department of Education uses the FAFSA to analyze students’ income sources, family assets, and family size, among other factors, in determining the amount of need-based grants and loans offered to applicants.
A 529 plan owned by a student or the student’s parents is considered an asset of either the student or parent, and the value of that asset will ultimately reduce the amount of student aid awarded. (That value generally reduces eligibility by up to 5.64% of the 529 plan account value if owned by the parent or up to 20% if owned by the student).
Before the recent changes to the FAFSA, financial aid packages could be significantly reduced for student applicants who were beneficiaries of 529 plans owned by someone other than themselves or their parents, such as a grandparent.
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In those cases, the value of a 529 account wasn’t a reportable asset on the FAFSA, but any distributions from the account were considered income to the student. And that income could reduce the student’s financial aid by up to 50% of the distributions! For example, a $20,000 distribution from a grandparent-owned 529 could reduce the student’s financial aid package by $10,000.
The new, “simplified” version of the FAFSA includes several changes to how income sources are reported and aid is calculated. The new FAFSA no longer requires applicants to report cash support or distributions from grandparent-owned 529s. This means that a grandparent can 1) be the owner of a 529 plan. with all the control and flexibility that comes with account ownership; 2) contribute money toward their grandchildren’s education and enjoy tax-free growth; and 3) be assured that money can be distributed to their grandchildren without any impact on the student’s federal financial aid.
Furthermore, you may live in one of the thirty states that allow state income tax deductions for contributions to in-state 529 plans. And if you happen to reside in Arizona, Arkansas, Kansas, Maine, Minnesota, Missouri, Montana, Ohio, or Pennsylvania, you can get a state tax benefit for contributions to any state’s 529 plan.
Too good to be true?
You may be wondering if there’s a catch. Of course there is. While the FAFSA has adopted this change in income reporting, 529 distributions are still a consideration on the College Scholarship Service (CSS) profile, which is used by almost 400 private colleges and universities in determining eligibility for institutional, non-federal aid. And since institutional aid is often larger than federal aid, this is an important consideration.
Distributions from a grandparent-owned 529 plan might need to wait until a student’s junior or senior years, for example, which could minimize or eliminate the effect on reportable income for those years. Or, if your state’s 529 plan allows it, ownership of the account might be transferred to a parent.
Always a Great Option: Contributions to Parent-Owned 529 Plans
After you’ve crunched the numbers and read the fine print, if a grandparent-owned 529 plan will not be the best route for your family, as grandparents you still have the option of giving annually to parent-owned 529 plans. Currently, you can contribute up to $19,000 per beneficiary each year to a 529 plan without counting toward your lifetime gift and estate tax exemption ($13.99 million for 2025, increasing to $15 million in 2026).
Additionally, 529 plans include a five-year rule that allows you to front-load five years’ worth of gifts at once. For example, you could contribute up to $95,000 in 2025 for one beneficiary—and treat it as if the gift were spread evenly over five years for tax purposes. A married couple could double that and contribute up to $190,000 per beneficiary in 2025.
Keep in mind that if you use this option, you won’t be able to make additional gifts to that same beneficiary for the next five years. And remember, if you’re fortunate enough to have over-funded a 529 plan, there is great flexibility in what you can do with leftover funds, including changing the beneficiary to another family member for their future educational expenses.