New changes to the 2024 FAFSA form may make contributing to 529 plans more attractive to families as they grapple with funding expensive college costs.
529 plans have been a valuable method for grandparents to help families save for significant college expenses. With a 529 plan, grandparents are enabled to fund an educational legacy for grandchildren while leveraging tax and estate planning benefits. With the new FAFSA (Free Application for Federal Student Aid) form, which is in effect starting with the 2024-2025 academic year, 529 accounts owned by grandparents will no longer have an adverse effect on a grandchild’s financial aid eligibility.
Under prior FAFSA rules, grandparent-owned/funded 529 plans could have a negative impact on financial aid eligibility for the student beneficiary. But under the new rules, grandparents no longer have to be concerned about the potential financial aid trap.
The new FAFSA has been scaled down and simplified as two-thirds of questions have been removed—including an important one that asks about cash gifts from grandparents, thereby eliminating the amounts from the calculation of eligibility for tuition assistance.
Generally, 529 plans have a minimal impact on overall financial aid. Parent-owned 529 plan assets are reported on the FAFSA as parent assets. Parent assets can only reduce aid eligibility by a maximum of 5.64% of the account value. On the other hand, grandparent-owned 529 plans were not reported as assets on the prior FAFSA at all, which would seem to have made them more attractive.
However, the difference came in how distributions were treated under the prior FAFSA rules. While the old FAFSA ignored distributions from a parent-owned 529 plan, distributions from grandparent-owned 529 plans were reported as untaxed student income. Untaxed income to a student can reduce aid eligibility by as much as 50% of the amount of cash support. For example, taking a $10,000 529 plan distribution to help pay for college could reduce your grandchild’s aid eligibility by $5,000 under the previous rules.
This is why the rule change is so significant. Now, a grandparent will be able to open a 529 plan for their grandchildren and help them pay for college without hurting their financial aid eligibility.
Importantly, parents of the child can take advantage of this by gifting their 529 plan to grandparents.
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Contributions from grandparents to parent-owned plans
Almost all 529 plans accept gift contributions by check or some other payment platform that allows friends and family to make secure electronic deposits. The SS&C gifting solution simplifies these gift contributions from friends and family to a child’s 529 account, helping to grow their college savings. The solution allows the giftor to contribute to the beneficiary’s account via a gifting link that navigates to an online platform that accepts many forms of payment.
Gift tax consequences
While there are many tax advantages to 529 plans, it is important to be aware of gift tax implications for gift contributions:
- Whether you contribute to 529 plan accounts owned by you or to accounts owned by the parents or someone else, your contributions are considered gifts to the account beneficiary. Gifts below the annual exclusion amount are generally tax-free and not subject to gift tax. However, a generation-skipping transfer tax might apply if the beneficiary is your grandchild.
- For contributions exceeding the annual exclusion amount, you may elect to treat the contribution as being made over a 5-year period by filing a gift-tax return. This allows you to front-load contributions into a 529 plan without exceeding the annual gift exclusion limit. The annual gift tax exclusion amount applies per donor per beneficiary, so couples can contribute a larger sum per beneficiary without gift-tax consequences, or a higher amount with 5-year averaging.
- For estate planning purposes, if your total gifts (including 529 plan contributions and other gifts) to an individual exceed the annual exclusion amount, the excess will count against your lifetime estate tax and gift tax exemption. It must be reported on a gift-tax return when you file your taxes. Estate and gift taxes will apply only if your gifts exceed the lifetime exemption limit.
State tax benefits
Gift contributions to 529 plans may qualify for a state income tax benefit. More than 30 states provide residents with a state income tax deduction or income tax credit for at least some of their 529 plan contributions. In most states, residents may claim the income tax benefit only when using an in-state 529 plan.
Download our "Transform Your 529 Plan Management with SS&C" brochure to learn more about how SS&C can help you navigate recent legislative changes for 529 college savings accounts.
