The 529 education savings plan got a couple of big upgrades in 2024 as a tool to save and pay for school.
Starting this year, Congress is allowing up to $35,000 in leftover savings in the plan to roll over tax-free into Roth individual retirement accounts, eliminating fears unused money could forever be trapped or incur taxes. Then, at the end of December, the Department of Education revised the Free Application for Federal Student Aid (FAFSA), creating the so-called grandparent loophole.
The grandparent loophole allows grandparents to use a 529 plan to fund a grandchild’s education without affecting the student's financial aid eligibility. Previously, withdrawals could have reduced aid eligibility by up to 50% of the amount of the distribution.
“A $10,000 distribution from a grandparent-owned 529 may reduce the following aid award by $5,000” under prior rules, wrote William Cass, director of wealth management programs for Boston, Mass.-based asset manager Putnam.
Beginning with the new 2024-25 FAFSA launched late last year, a student’s total income is only based on data from federal income tax returns. That means any cash support, no matter the source, won’t negatively affect financial aid eligibility.
Though it’s called the “grandparent loophole,” any nonparent, including friends and relatives, can use it.
Previously, distributions from any nonparent-owned 529 plan were included as untaxed student income, which reduced eligibility for need-based aid. To avoid this, people got crafty with timing distributions.
Since the prior FAFSA was based on financial information going back two years, people waited until the last two years of college before tapping nonparent 529s to minimize the negative effect withdrawals would have as income.
Since the new FAFSA doesn’t count any of these distributions as income, no one needs to worry about any of this anymore, said Tricia Scarlata, head of education savings at J.P. Morgan Asset Management.
The grandparent loophole and Roth IRA rollover are just the latest benefits added to the 529 plan, which Scarlata says is her favorite education savings plan.
“It’s the plan you can contribute the most amount, get tax-free growth and withdrawals and some in-state tax benefits,” she said.
Other advantages include:
Contributions aren’t tax-free on a federal basis, but withdrawals are tax-free for qualified expenses like tuition and fees, books and other supplies or up to $10,000 annually for K-12 tuition.
Most states will give you a tax break for contributions if you invest in the state’s 529 plan. Check your state’s rules.
A handful of states offer “tax parity,” which means you can deduct at least some of your contributions to any plan in the United States, not just the one provided by your state.
Contributions are considered gifts. For 2024, the annual gifting limit is $18,000 for an individual or $36,000 for married couples so you can contribute up to that amount in a 529 without incurring the IRS’ gift tax. That amount is per beneficiary so parents, grandparents and others may gift that much annually to each student.
“Accelerated gifting” allows you up to five years of gifting in a 529 in one lump sum of $90,000 for an individual or $180,000 for a couple. If you can afford it, this allows the full amount to grow tax-free longer.
You can invest contributions and allow the balance to grow tax-free. Despite this benefit, Scarlata said about half of Americans keep their money in cash and cash-equivalents like certificates of deposit (CDs) or savings accounts. With college tuition rising about 8% annually, keeping those types of assets in your 529 isn't going to help you pay for college, she said. The broad-market S&P 500 stock index, on the other hand, returns 10% annually on average, giving you a shot at ramping up your savings.
The grandparent loophole allows grandparents to use a 529 plan to fund a grandchild's education without affecting the student's financial aid eligibility. Previously, withdrawals could have reduced aid eligibility by up to 50% of the amount of the distribution.
The FAFSA Simplification Act brings a lucrative “grandparent loophole” that allows you to contribute generously to a 529 plan without jeopardizing your grandchild's eligibility for financial aid. This opens up a wealth of strategic opportunities for families.
One of those changes is known as the 'Grandparent Loophole', which now makes college payments made by grandparents exempt from the form. Previously, the FAFSA application counted grandparent contributions as untaxed student income under a 529 plan.
In most cases, a grandparent owning and using a 529 account for a grandchild will not affect the grandchild's eligibility for need-based financial aid.
Additionally, in 2024 you can front-load a 529 plan (giving 5 years' worth of annual gifts of up to $18,000 at once for a total of $90,000 per person, per beneficiary) without having to pay a gift tax.
On the 2024-25 FAFSA, students are no longer required to report cash gifts from a grandparent or contributions from a grandparent-owned 529 savings plan. Because of this, grandparents can now use a 529 plan to fund a grandchild's education without impacting their financial aid eligibility.
The grandparent loophole allows grandparents to use a 529 plan to fund a grandchild's education without affecting the student's financial aid eligibility. Previously, withdrawals could have reduced aid eligibility by up to 50% of the amount of the distribution.
Did You Know? There is no income cut-off to qualify for federal student aid. Many factors—such as the size of your family and your year in school—are taken into account.
The 2024–25 FAFSA form expands eligibility for federal student aid, including Pell Grants, and provides a streamlined user experience. An estimated 7.3 million students from low-income backgrounds will be eligible to receive Federal Pell Grants due to updates to student aid calculations.
The following people are not your parents unless they have legally adopted you: grandparents, foster parents, legal guardians, older brothers or sisters, uncles or aunts, and widowed stepparents.
529 plan distributions receive favorable treatment on the FAFSA. Qualified distributions from a student-owned or parent-owned 529 account to pay for this year's college expenses are not included in the “base-year income” that would reduce college financial aid eligibility.
529 plans are one of the best ways for grandparents to save for college because while contributions to a 529 plan are not deductible at the federal level, over 30 states offer a tax deduction or credit for contributions.
Beginning with the 2024-25 FAFSA, parents who are required to provide asset information on the FAFSA will only provide information about the 529 accounts designated for the student whose FAFSA they are completing.
How does the new law change affect excess 529 plan funds? In December 2022, SECURE Act 2.0 was signed into law to enhance retirement savings opportunities for Americans. One provision — effective in 2024 — allows owners of a 529 plan to move unused funds in the account directly to the plan beneficiary's Roth IRA.
Individuals may contribute as much as $90,000 to a 529 plan in 2024 ($85,000 in 2023) if they treat the contribution as if it were spread over a five-year period. The 5-year election must be reported on Form 709 for each of the five years.
There are no time or age limits on using a state 529 college savings plan. Money can be kept in a 529 plan indefinitely. 529 plans can be used for graduate school, not just undergraduate school, and can be passed on to one's children.
Is it better for a grandparent or parent to own a 529 plan? Many advisors will push people to have the parent own the 529 plan because recent rules have grandparent contributions hurting total financial aid eligibility.
Only the person claiming the student's dependency (usually the parent) can claim a tuition credit (there is no deduction). But that person can claim the money paid by any other person (what you, the grandparent paid) in calculating the credit.
There are a number of valuable ways that grandparents can use a 529 college savings plan to help with a grandchild's higher education goals. While the grandparent can set up their own 529, they can also contribute to a 529 plan owned by a parent of the grandchild, Roberts says.
The recent overhaul aims to make the financial aid process more equitable and reflective of a student's true financial need. Under the new FAFSA guidelines, money contributed by grandparents for a grandchild's education will not be factored into the calculation of a student's financial aid eligibility.
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