By: Joseph Goldy, CFP®
Changes in the FAFSA Free Application
Beginning with the 2024/25 school year, the Department of Education plans on some significant changes to the Free Application for Federal Student Aid (FAFSA). Aside from simplifying the form by reducing the number of questions from over 100 to less than 40, one of the most significant changes lies in how distributions from grandparent-owned 529 plans are treated toward financial aid.
How Grandparent-owned 529 Plans are Counted for Financial Aid Purposes
Currently, any assets held in a 529 plan owned by a grandparent have been disregarded for financial aid purposes, which is helpful for students.
However, negating some of this benefit is that distributions from grandparent-owned plans are considered income for the student. This rule is particularly disadvantageous since up to 50% of student income above the $7,040 allowance (2022/23) is counted against financial aid.
Since the FAFSA is always looking back two years, the negative impact of grandparent-owned 529 distributions can be mitigated by timing them until the student’s sophomore year.
Proposed Changes for 529 Plan Distributions for Grandchildren
However, with the proposed changes, the timing of distributions will no longer be necessary. Assuming the announced FAFSA updates become a reality, the Department of Education will begin pulling student income directly from federal tax returns via the IRS Data Retrieval Tool.
Since distributions from grandparent-owned plans are not earned income from the student appearing on their tax return, they would no longer count against students in the income category.
Graphic credit: Savingforcollege.com
This change will be a real plus for students since grandparents will be able to distribute any amount they want, and it will not count against the student’s aid eligibility.
Your Grandchild’s 529 Plan Can Help to Reduce Your Taxable Estate
This rule change has an ancillary benefit since grandparent-owned 529 assets already do not count as student assets. Knowing that distributions from these plans will no longer work against the student’s financial aid, grandparents looking for ways to reduce their taxable estate while helping with college can “superfund” a grandchild’s 529 plan.
How Much Can Grandparents Contribute to Grandchild’s 529 Plan?
The IRS allows people to put up to 5 years’ worth of 529 plan contributions in at one time. Grandparents who desire to reduce their taxable estate for planning reasons can take advantage of this rule by making the annual maximum 529 contributions of $80,000 ($16,000 (2022) x 5 years) in a lump sum. Married couples can make up to a $160,000 contribution while still staying below the annual gift tax exemption limit.
This technique can be repeated every five years if desired, although you will begin to run up against 529 plan maximums depending on which state’s plan you’re using. At HIGHLAND, we work with clients to evaluate optimal estate planning strategies such as this.
While some slight modifications to the FAFSA are beginning to roll out this school year, the change in income recognition for students receiving grandparent-owned 529 distributions is still a couple of years away. We will continue to monitor the Department of Education timeline and provide updates in the future.
Joseph Goldy, CFP®, is a wealth advisor and CERTIFIED FINANCIAL PLANNER™ at Highland Financial Advisors, LLC, a fee-only fiduciary wealth advisory firm based in Wayne, New Jersey.
Joe specializes in working with newly independent women because of divorce or losing a spouse. He understands firsthand the value of having a clear financial picture pre- and post-divorce and a plan to restate goals as a single person. When he is not helping clients, Joe enjoys spending time with his two sons outdoors and volunteering to help raise money for Type 1 diabetes organizations.