‘Grandparent Loophole’: This New FAFSA Rule Can Help Maximize College Savings

• 529 savings plans are tax-advantaged investment accounts designed to encourage saving for future education expenses.
• Students have to report untaxed student income on their FAFSA forms when applying for financial aid.
• New FAFSA rules will not count funds from grandparent-owned 529 accounts as untaxed student income, increasing the student's eligibility for student aid.

Today, 529 savings plans are a popular way of saving money for college and offer many benefits to account owners. Anyone can open a 529 account for the student in their life. And thanks to new Free Application for Federal Student Aid (FAFSA) rules, grandparent-owned accounts will no longer factor into student aid eligibility.

What Are 529 Accounts?

These savings plans are tax-advantaged investment accounts designed to encourage saving for future education expenses. All 50 states and the District of Columbia sponsor at least one type of 529 plan with varying restrictions and tax benefits.

"Across the country, there are several 529 plans to choose from, and they offer a lot of savings options that really are appealing because of the combination of the tax advantages, the control that account owners have over the account, and the flexibility," said Rachel Biar, chair of the College Savings Plans Network and the assistant state treasurer for the Nebraska 529 College Savings Program.

All earnings from a 529 account are tax-free when used for qualified educational purposes including tuition, fees, and textbooks. Biar told BestColleges that many states also offer income tax deductions for 529 accounts.

"On top of getting the tax advantages on the earnings being tax-free, and the distributions coming out tax-free, [account owners] also get that in-state tax deduction if their state offers that, so it's really a nice combination for families to take advantage of," she said.

Grandparent Loophole

Previously, students reported any funding from a grandparent-owned 529 plan as untaxed student income on their FAFSA. Contributions from grandparents would count against the student's financial aid eligibility.

However, the new rules will not require students to report any cash funding they have gotten for college, including grandparent-owned 529 accounts, when applying for financial aid. This means that grandparent-owned 529 plans will not impact financial aid eligibility.

The new rules go into effect for the 2023-2024 school year, although grandparents hoping to help the students in their life save for college can start now since FAFSA considers the past two years of a student's income.

Biar says the rules change is a "nice advantage" for grandparent-owned accounts.

"Basically when a grandparent owns the account now, there will be no impact on the students on the financial aid form, which is really positive," she said.

Setting Up Your Plan

Biar says it is never too early or late to set up a 529 plan for a student. She recommends talking to family members about donating to a student's plan for special occasions as a way to build up savings.

"There's so much versatility of 529 plans, and they really can make a difference in building that flexibility into the college savings journey … I always think it's good for families to talk to grandparents about holidays [and] birthdays … It's really a nice time to put a gift of a 529 contribution into their account. Grandparents sometimes have a better ability to help save, and so definitely get the whole entire family involved."

Biar calls saving for college a "family affair" and says she has 529 accounts for her nieces and nephews.

"Having those conversations early and helping guide that student's path is a benefit to everyone, particularly the students as they enter their higher education career," she said. "Knowing that they have some savings that will help them is less stressful as they navigate the costs that come with college."