One of the first questions I often get asked after clients welcome a new baby into their family is, “what is the best way to save money for their college education?” Not only are the baby’s parents interested in saving as much as possible for their child’s college education, but grandparents are often interested in contributing, as well. In this way, saving for college can be a family affair.

529 Plans

With the cost of college continuing to hit new highs, many clients want to start saving as soon as possible for their loved ones. As a result, I often end up advising them to open a 529 account to maximize their tax benefits.

529 plans not only encourage college savings by offering tax free growth and, in some cases, state level tax deductions, they also receive favorable tax treatment on the Free Application for Financial Aid (FAFSA), the federal student aid application used for college and graduate school. 

529 accounts held by a student’s parents for their benefit are treated as the parent’s asset instead of the student’s, meaning they don’t count against the student as much when their expected family contribution is calculated on the FAFSA.

In the past, when grandparents wanted to set up 529s for their grandchildren, the titling of those accounts has been tricky. If the grandparent was listed as the owner of the 529 account, the student wouldn’t have to report it as an asset on their FAFSA.

On the surface, this would seem ideal, but there was a big trap lurking: when the grandparents made distributions to fund their grandchild’s education, the student would be required to report those distributions as non-taxable income to themselves. In the expected family contribution formula, income to the student has the biggest negative impact. So well-meaning grandparents could inadvertently find themselves reducing the amount of aid their grandchildren were eligible for if they weren’t working with a knowledgeable advisor.

Changes Expected

These complicated rules are scheduled to go away starting with the 2024-2025 school year thanks to the Consolidated Appropriations Act of 2021. This legislation contains provisions that would simplify the FAFSA by eliminating almost two thirds of the questions on the form. It also mandates the FAFSA must rely on the IRS database to gather information for the student filing instead of requiring the student to supply all information.

One of the questions removed from the form is about gifts from grandparents and other family members. This means that under the streamlined FAFSA, students will not have to report distributions from grandparent owned 529s at all.

This change presents a planning opportunity for families where the grandparents are interested in funding a 529 plan on behalf of their grandchildren. Assets contributed to the grandparent-owned 529 will no longer count against the student either as an asset or income on the FAFSA. The student’s parents can also contribute to this account to save on their child’s behalf without it counting against their child when it comes to filing for financial aid.

There are, of course, things to consider when relying on a grandparent-owned 529. The grandparents are the owners, so they have ultimate control over the funds. They are in charge of when the money is distributed and can even change the beneficiary on the account at any time. If parents have any concern that their child’s grandparents might not reliably distribute funds on their child’s behalf, contribution to that fund may not be the best course of action. And if the child’s grandparents pass away before the child reaches college, this setup will not have any added value for the student.

CSS Considerations

There is also a major caveat to these changes: they only apply to the FAFSA; they do not apply to the College Scholarship Service (CSS) profile. The CSS profile is an alternate form for determining aid used by many private schools and can be customized by any school to look at things like real estate, assets of the non-custodial parent, and grandparent-owned 529 accounts.

If the student attends a school that uses the CSS profile, this will be important to keep in mind. For many, 529s are a very useful college savings technique to employ. Knowing the best way to manage a 529 for your child or grandchild can help set them up for success academically and financially.

The Bottom Line

If you have questions about what is best for your individual case, be sure to talk to a trusted advisor who knows your financial and personal situation