New College Savings Option: How to Get More Money Without Impacting Financial Aid

Background
529 college savings plans provide a way to contribute after-tax money into an account designated for a beneficiary (the student). The plan is controlled by the account holder on behalf of the student, so there is little risk that the funds won’t be used as intended for education. As the deposits grow over time, any gains on the deposits are tax-free as long as they are used for qualified educational expenses. Even better, these funds can be used for both college and K through 12 qualified expenses. Funds not used for education will be subject to ordinary income taxes AND a 10% penalty.

The Problem
While anyone can open a 529 savings plan for a future student, any time a distribution was made to the student from a non-parent account, that distribution used to be treated as untaxed income to the child. Up to 50% of this distribution could impact the student’s ability to receive other aid through the Free Application for Federal Student Aid (FAFSA). On the other hand, if the account is in the parent’s name, the reduction in aid eligibility is maxed out at 5.64%!

The New Opportunity
It appears now that a grandparent (or potentially any non-custodial parent or friend) can open up a 529 savings plan without it hurting the future student’s ability to get federal aid. In the eyes of the new FAFSA, this funding is now virtually invisible to them as they calculate a student’s financial needs because they are no longer asking the questions about the grandparent’s contributions. So not only will the assets in the 529 account be ignored, but the distributions from the 529 account will also not influence the FAFSA results.

Considerations
If you are considering this option to help fund the ever-increasing cost of college, here are some considerations and ideas:

• Let grandparents know of the change. Consider having your parent set up an account for the benefit of your child (their grandchild). Then put their gifts into the account, instead of giving cash to your child. Remember, they can contribute up to the gift threshold limit each year (currently $17,000 per person in 2023) or even more with special funding rules.
• No college? No problem. If your grandchild does not go to college and there isn’t a need to fund K through 12 education, you can change the beneficiary to another grandchild or family member.
• Need to pull the money. If you need to pull the money, remember that the original contributions are tax and penalty free. Taxes and penalties only apply to earnings in the account that are distributed.
• Consider other applications. If the student goes to a private school, these grandparent contributions may need to be disclosed, so plan accordingly.

Given the ever-increasing cost of college, now is a great time to have more advocates helping to save for future educational expenses. These extra savings could make a big difference in reducing your student’s future debt obligations.