The New 529 Grandparent Loophole for Financial Aid

Grandparents wishing to contribute to a grandchild’s higher education costs have historically faced a complex decision regarding 529 savings plans. While these accounts are a popular vehicle for college savings, rules surrounding financial aid applications created a potential penalty for families receiving grandparent support. Recent legislative changes have directly addressed this long-standing issue, altering the financial aid landscape for grandparents helping to pay for college.

The Original Financial Aid Trap for Grandparent 529 Plans

Previously, federal financial aid rules created a complication for students with grandparent-owned 529 plans. As an asset, the account was not reportable on the Free Application for Federal Student Aid (FAFSA) because neither the student nor the parent owned it. This preserved the student’s initial eligibility for need-based aid.

The problem arose when a grandparent used the funds. A qualified distribution from a grandparent-owned 529 plan to pay for tuition or other expenses was treated as untaxed income to the student. This distribution would then have to be reported on the student’s FAFSA for the following academic year.

Under the old FAFSA formula, student income was assessed at a much higher rate than parent assets, and aid eligibility could be reduced by up to 50% of the distribution amount. For example, a $20,000 payment from a grandparent’s account could reduce a student’s financial aid package by as much as $10,000 the following year. This consequence forced families into complicated workarounds, such as waiting until the student’s final years of college to use the funds after their last FAFSA had been filed.

The FAFSA Simplification Act’s Solution

The FAFSA Simplification Act fundamentally changed the rules for grandparent-funded 529 plans, with changes taking effect for the 2024-2025 FAFSA. The legislation overhauled the federal student aid process by removing the specific question that was the source of the complication.

The updated FAFSA form no longer asks students to report cash support they received. This includes monetary gifts from family members, such as distributions from a 529 plan owned by a grandparent.

As a result, a qualified distribution from a grandparent-owned 529 plan no longer has any bearing on a student’s federal aid eligibility. The funds are not reported as an asset, since the student does not own the account, and are no longer reported as student income on the FAFSA.

This change means that grandparents can now contribute to a grandchild’s education from their 529 plan at any time without negatively impacting the student’s federal financial aid package in a subsequent year. The funds can be used for the first semester of freshman year just as safely as they could for the last semester of senior year.

Strategic Considerations for Grandparent Contributions

While the federal aid complication has been resolved, grandparents should still weigh several factors. Grandparent ownership of the 529 plan means the account holder retains full control over the investment and distribution of the funds. This control allows the grandparent to ensure the money is used for its intended purpose and to change the beneficiary to another eligible family member if the original grandchild does not attend college.

However, ownership also has potential estate planning implications. Upon the grandparent’s death, the treatment of the 529 account can vary. Some plans may require the designation of a successor owner, while others might treat the account as part of the deceased’s estate, potentially subjecting it to probate. For individuals concerned about qualifying for Medicaid, funds in a 529 account could be considered an asset during the look-back period, which can affect eligibility.

Contributions to a 529 plan are considered completed gifts for tax purposes. For 2025, an individual can gift up to $19,000 per recipient without any gift tax consequences or filing requirements. A feature of 529 plans allows for “superfunding,” where an individual can make a lump-sum contribution of up to five times the annual exclusion amount—$95,000 for an individual or $190,000 for a married couple in 2025—and treat it as if it were made over five years. This must be reported on a Form 709 gift tax return, but it allows for significant front-loading of an account.

A final caveat exists for students applying to certain private colleges and universities. While the FAFSA rules have changed, hundreds of institutions use an additional form, the CSS Profile, to determine eligibility for their own institutional aid. The CSS Profile has different rules and may still require students to report expected support from grandparents. Therefore, a distribution from a grandparent’s 529 plan could still reduce institutional aid at a school that uses this application, and families must verify the specific policies of each college.