Unpacking the 529 Grandparent Loophole & What It Means

The Grandparent Loophole: What It Is & How It Works

There’s great news for grandparents with 529 accounts: saving for achild’s future education just becomes much easier. Thanks to a recent legislative update and the new “529 grandparent loophole,” grandparents who own a 529 account can make significant contributions to their grandchild’s education savings without necessarily affecting the grandchild’s eligibility for federal student aid.

How does this loophole work? What does it mean for 529 plan savings, and how can you take advantage of the loophole? We’ll go over the answers to all these questions below.

The FAFSA Simplification Act

Beginning this academic year, the FAFSA Simplification Act goes into effect. The new law is a comprehensive federal student aid process overhaul that affects many aspects of the Free Application for Federal Student Aid process, including how the form is filled out, how financial need is calculated by the government, and more.

Key Changes in the FAFSA Simplification Act

The FAFSA Simplification Act significantly transforms how students’ ability to pay for college is determined. The previous “Expected Family Contribution” (EFC) measurement has been replaced with the “Student Aid Index” (SAI). The new SAI formula removes the number of family members in college from the calculation, allows a minimum SAI of -1500, and implements separate eligibility determination criteria for Federal Pell Grants.

The FAFSA Simplification Act also modifies how an applicant’s family size is determined, so it more closely matches what the applicant or the applicant’s parents report on their tax returns. Additionally, the new FAFSA form is markedly shorter because it automatically pulls tax information from the IRS.

All these changes could substantially alter how aid is awarded for current and future college students. And thanks to this legislation, 529 account owners who are grandparents have something particular to look forward to. It’s called the “grandparent loophole”

What is the 529 Grandparent Loophole?

Before the FAFSA Simplification Act, distributions from 529 plans owned by an applicant's grandparents were counted as untaxed student income – and those distributions had the potential to reduce a student’s financial aid eligibility.

Before the FAFSA Simplification Act, grandparents might open 529 accounts for their grandchildren and tuck money away for years. Unfortunately, if grandchildren accepted distributions from their grandparent-owned 529 accounts, they could potentially make themselves less eligible for student aid from the federal government when they filed the FAFSA for their next academic year.

That’s all changed with the FAFSA Simplification Act. Under the Act’s new rules, grandparent-owned 529 plans will no longer have an impact on need-based federal financial aid eligibility. Grandparents can now freely contribute to and withdraw money from their 529 accounts for the benefit of their grandchildren’s education without worrying about reducing the financial aid those grandchildren may receive from the government.

Starting in 2024, the FAFSA form only accounts for untaxed income reported on the student’s federal income tax return. That means other cash contributions, like gifts from other family members, won’t reduce their federal aid eligibility.

Altogether, these changes should make it easier for students to pay for school by combining aid from several sources, including 529 plans, federal aid, and scholarships – and make your gift of a 529 contribution even more impactful.

Exceptions to the Grandparent Loophole

While the grandparent loophole is an amazingly helpful change, it's important to remember that it doesn't universally apply to all aid applications or sources.

Specifically, private schools that use the College Scholarship Service (CSS) profile are legally allowed to require students to report their grandparent-owned 529 plan distributions as income for their aid calculations. In short, distributions from a grandparent’s 529 plan can still impact financial aid from specific institutions, though this policy varies from school to school.

529 Plan Benefits to Grandparents

For grandparents, the biggest benefit to contributing to a grandchild’s 529 account is the chance to take a heavy financial weight off their shoulders. You can make your grandchild’s future education affordable and attainable with regular or lump sum contributions. However you choose to contribute, your money has the potential to grow over time.

Your grandchild will benefit from contributions you make on their behalf as long as the funds are used for qualified education expenses. This priceless gift allows grandparents to help their grandchildren achieve their dreams.

What’s more, setting up or contributing to a 529 account may provide you with significant tax breaks. In South Carolina, residents who save with the Future Scholar 529 plan deduct 100% of their contributions from their S.C. state income taxes, lowering their overall taxable income.

Grandparents can also use 529 plans as estate planning tools. Contributions to 529 accounts utilize the annual gifting exclusion, meaning up to $18,000 (or $36,000 for married couples) of contributions are excluded from the annual gift tax and removed from your taxable estate.  

You can also make a lump-sum contribution of up to five times the normal annual amount ($90,000 or $180,000 for married couples) using an exclusive forward-gifting feature  available only to 529 accounts. This is a fantastic way for grandparents to jumpstart 529 savings and expand educational opportunities for their grandchildren.

Grandparents and 529 Plans: Getting Started

Since grandparents’ accounts will not affect federal aid eligibility moving forward, there’s no better time to open an account and start contributing than right now. Opening a 529 account is as easy as 1-2-3:

• Gather your information as well as information about your beneficiary, including name, date of birth, Social Security Number, and address.
• Decide your initial contribution method and choose your investments.
• Finalize your 529 enrollment online, via mail, or with a Future Scholar Enrollment Kit.

Does your grandchild already have a 529 account? Great! You can still open an account to take advantage of the grandparent loophole. With Future Scholar, saving for your grandchild’s future education is simple, fast, and secure.

Want to learn more about Future Scholar 529 accounts? Visit our website and enroll today