Personal Finance | September 24, 2021

Own a 529 for a Grandchild? Read the Fine Print

When a baby is born, parents face a whole host of new expenses. Saving for their child's college education—which, like retirement, benefits greatly from early action—may not be high on their list of priorities. 

At the same time, grandparents are often eager to help out financially. In such instances, a grandparent-owned 529 college savings plan can be just what the doctor ordered.

Assets in state-sponsored 529s have the potential for growth that is tax-deferred, and withdrawals are exempt from federal taxes when used for qualified education expenses. As an added benefit, you may also be able to deduct contributions on your state taxes: The District of Columbia and 34 states offer a full or partial tax credit or deduction for in-state contributions to their 529 plans, and Arizona and Kansas offer a full or partial tax deduction to any state's plan.1

Not only that, but grandparent-owned 529 assets aren't factored into the Free Application for Federal Student Aid (FAFSA®), which helps determine eligibility for grants, work-study programs, and loans. With parent-owned 529s, on the other hand, 5.64% of assets are counted.2

Under current FAFSA rules, once a distribution from any nonparent-owned 529 plan is made, up to 50% of those funds must be reported as untaxed income on a student's future financial aid applications. Federal financial aid calculations count such distributions only from the "prior-prior year"—that is, two tax years before the funds were distributed. Hence, delaying distributions from nonparent-owned accounts until the final two years of a child's college career can help sidestep this potential pitfall.

Change on the Horizon

With the passage of the FAFSA Simplication Act (part of the Consolidated Appropriations Act, 2021, enacted by Congress in December 2020), the new FAFSA form will not require funds from grandparent-owned 529s—as well as gifts—to be reported. This change may not happen until the 2024–2025 school year, so you'll have to wait at least a year to benefit from the "prior-prior year" rule mentioned above.

Take note, however, that a grandparent-owned 529 will likely continue to be considered on the College Scholarship Service Profile (CSS Profile™) application used for institution-specific financial aid. If you time it right, you can help a grandchild pay for college with a grandparent-owned 529 without affecting financial aid eligibility.

1For a complete list of deductibility by state, see finaid.org/savings/state529deductions.phtml.

2Assets and income may be excluded from calculations if below certain thresholds. For more details, see studentaid.ed.gov.

What You Can Do Next