How the FAFSA’s grandparent ‘loophole’ works
The simplified FAFSA form now uses a new calculation called the “Student Aid Index” to estimate how much a family can afford to pay.
Previously, many factors went into how much aid students receive, including the total number of people in the household and the number of children in college, as well as various sources of income.
Under the old FAFSA rules, assets held in grandparent-owned 529 college savings plans were not reported on the form, but distributions from those accounts counted as untaxed student income. The formula could reduce aid by up to half of that income.
“That was a very serious penalty,” said higher education expert Mark Kantrowitz.
Now, this new formula pulls federal tax information directly from the IRS and slims 108 questions down to less than 50.
Middle-income families may benefit the most
Without those questions about other sources of income, middle-income families who have the capacity to save will benefit the most, according to Michael Green, a financial advisor at Apollon Wealth Management in Charleston, North Carolina.
Green advises his clients to open a 529 plan for their grandchildren to help them pay for college, when that fits with their financial goals, especially now that there’s less of a chance of it hurting their aid eligibility.
“If it’s possible to have them off the radar, it’s definitely helpful,” he said.
One caveat for parents, Green added: “You are taking the reins and giving it to someone else, that requires some thought and requires that families be on the same page.”
The grandparent owns and controls the account and that money can be considered an asset for their Medicaid eligibility purposes, which is another aspect worth noting for planning purposes.
Still, the idea of a loophole is not entirely new, according to Kalman Chany, a financial aid consultant and author of The Princeton Review’s “Paying for College.”
“There were always planning strategies that families could use when it came to third-party 529 plans,” Chany said.
And even now, colleges may still take some contributions from grandparents into account on the CSS profile to award nonfederal institutional aid, he added.
“Even with this change, you still need to look before you leap if grandparents are going to help pay for college,” Chany said.
The other advantages of 529 plans
Already, experts widely consider 529 plans the best way to save for college. Further, restrictions have loosened in recent years to include continuing education classes, apprenticeship programs and even student loan payments. And, as of 2024, families can also roll unused money from 529 plans over to Roth individual retirement accounts free of income tax or tax penalties.
Any additional change that encourages families to save more for college is beneficial, according to Kantrowitz.
“Expanding the capabilities of 529 plans and sheltering them more is a step in the right direction,” he said.
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