Grandparent-Owned vs. Parent-Owned 529 accounts – Recent Changes and the Future Impact on Beneficiaries

January 3, 2023by Wes McNeillie0

The average annual cost of tuition for an in-state public university is just over $10,000. Add to that the costs of room and board, books and other supplies and that $10,000 becomes more like $25,000-$30,000. All-in, a four-year degree can easily cost over $100,000. Fortunately, there is a tax advantageous way to save for this exorbitant cost, a 529 account. 529 accounts are investment accounts designated for certain college (and more recently secondary) educational expenses. They offer a double-tax benefit: while contributions are funded with after-tax dollars, those dollars are then invested in which any earnings grow tax-deferred, and withdrawals from the account are tax-free if used to pay for qualified education expenses. While anyone can open a 529 account (as long as you are a U.S. citizen and 18 years of age or older), below I focus on two of the more common owners of 529 accounts – parents and grandparents.

If applying for any type of financial aid, scholarships, grants etc. then you have heard of the Free Application for Federal Student Aid, or FAFSA. The FAFSA asks for a wide range of financial information, both from the students and parents, that information gets input into the Expected Family Contribution (EFC) formula. The EFC determines the amount, if any, of federal financial aid the student is eligible for. Items included in the formula for determination of aid include past tax returns, balances of checking and savings accounts, brokerage accounts (non-qualified), equity in real estate that doesn’t include your primary residence, etc. One of the main factors to consider is how parent-owned assets and income vs. student owned assets and income affect financial aid. Parent-owned assets have less of an impact (5.64%) on their child’s eligibility for financial aid than student-owned assets (20%) and student income (50%). Where the issue lies with 529 accounts specifically, is how the EFC formula treats withdrawals from grandparent-owned 529’s. Whereas a parent-owned 529 account is treated as a parent asset with minimal impact on financial aid eligibility, withdrawals from a grandparent-owned 529 account is counted as untaxed student income, with a two-year lookback. For example, when you filed the FAFSA for the 2022-2023 school year, your income from 2020 is used to determine aid eligibility. So, withdrawals from a grandparent-owned 529 from 2020 would be counted as untaxed student income, which would show up on your 2022-2023 FAFSA. In the past, a workaround to avoid this would be to only make withdrawals from grandparent-owned 529 accounts during your Junior and Senior year, as that would not show up on your FAFSA until your four-years of undergraduate studies have been completed.

Fortunately, Congress passed the FAFSA Simplification Act back in December 2020, with a phased approach to implementation occurring over several years. Significant changes will go into effect for the 2024-2025 school year (which will show on the FAFSA that becomes available October 2023), which includes no longer classifying withdrawals from grandparent-owned 529s (or any nonparental-owned 529) as untaxed student income. Such withdrawals will no longer be required to be reported. Moreover, the EFC formula will be replaced by the Student Aid Index (SAI) to determine a student’s eligibility for aid. That will be a post for another day.

The takeaway is withdrawals from grandparent-owned 529’s from 2022 and beyond will have no impact on aid eligibility, providing more flexibility for grandparent’s who have the means to help assist with their grandchildren’s education costs.

Wes McNeillie

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