Grandparents and Others can Contribute More to 529 Plans without Affecting College Financial Aid

Q. My son, Bryan, is entering middle school. His grandfather (my dad) is coming for a barbecue for Father’s Day this weekend, and we are also celebrating Bryan’s birthday. My dad has been contributing to a 529 plan to help pay for Bryan’s future college education for years but is concerned about continuing to do so. My father heard that it can affect any college financial aid that Bryan may be eligible for and also could hurt my dad’s eligibility for Medicaid in the future if my dad ever needs nursing home care. My dad would really like to continue contributing to the 529, as he had been doing on birthdays and Christmas. Are his fears legitimate? Thanks for your help!

A. College has become very expensive. Even state schools can run you $30,000 a year and that is for freshmen entering college this year!

Tax-advantaged 529 college savings plans have become a popular way to pay for college because of their tax benefits. Here’s why: money invested in a 529 plan grows tax-free, and nobody has to pay taxes on withdrawals so long as the money is used for college or certain other education-related expenses.

Many think 529s are just for college. However, they can also be used to pay K-12 costs or even student loan repayments. 529s have become so popular in recent years that they reached $480 billion in the fourth quarter of 2021, up from $165 billion a decade ago, according to Federal Reserve data. In fact, 37 percent of families with kids in college used 529 plans in 2020, with the average account holding $25,664.

Grandparents Want to Contribute More to 529s for Their Grandchildren

Many grandparents want to contribute to a 529 account help pay for a grandchild’s college costs. But until recently, grandparent-owned 529 accounts were known as a “financial-aid trap,” which made some grandparents think twice before opening new accounts or adding to existing ones. Here’s why: Because while families applying for aid aren’t required to disclose grandparent-owned 529 account assets on the Free Application for Federal Student Aid (FAFSA), they are required to disclose any cash they receive from non-parent sources. The FAFSA then adds half that gift to what’s known as the Expected Family Contribution. That amount is then deducted from a student’s overall federal aid eligibility. So, money distributed to students from grandparent-owned 529 accounts was reducing the recipient’s eligibility for federal financial aid by 50 percent of the amount withdrawn for the student!

Changes Have Been Made to Eliminate the Financial Aid Trap

“The fear that a grandparent helping their grandchild by using their own 529 plan would interfere with them getting financial aid, that worry is gone now with the new rules,” said Stuart Siegel, president of college financial-aid service FAFSAssist.

The new FAFSA questionnaire, which will be in effect for the 2024-2025 academic year, no longer requires students to manually disclose cash support on the FAFSA. As a result of the Consolidated Appropriations Act of 2021, grandparents (along with noncustodial parents and anyone else outside of the custodial household) can finally contribute significantly to the cost of their grandchildren’s education without impacting any needs-based financial aid eligibility.

With the new form, the amount of a student’s “total income,” which includes untaxed income, will come directly from federal income tax returns via the IRS Data Retrieval Tool (DRT). So, a student’s total income amount will only consist of data that comes from the federal income tax return. And a grandchild does not have to report a distribution that was taken from a grandparent’s 529 plan, because that’s considered the receipt of a gift, and the receipt of a gift is never treated as taxable income to the recipient.

However, grandparent 529 plans are still considered on the CSS Profile. The CSS Profile is an additional financial aid form used by about 200 private colleges to award their institutional aid. Here is a list of colleges that currently require the CSS profile.

What Makes 529 Plans a Good Idea for Grandparents

As you can see, grandparents investing in a 529 plan to help send their grandchildren to college can now do so in most cases without fearing the financial-aid trap. 529 plans offer grandparents several advantages over outright gifting. Here’s some of them:

      • As already explained, 529 plans offer tax-free investment growth and distributions are tax-free when used to pay for qualified education expenses. These tax savings can help build a substantial college fund for a grandchild. Grandparents may also be eligible for additional state tax benefits, depending on where they live.
      • Contributions to 529 plans are considered completed gifts by the IRS and are removed from the grandparent’s taxable estate, despite the fact that the grandparent maintains control.
      • 529 accounts are incredibly flexible. For example, if the beneficiary decides not to attend college, the account owner can change the beneficiary to another family member.
      • Grandparents retain the flexibility to withdraw 529 funds for their own unexpected needs. However, this type of distribution will be taxable and might incur a 10% penalty.

A 529 plan is a smart investment that can set your grandchild up for future success. 529 plans already offer numerous benefits for grandparents, and the new financial aid rule described above make them even more attractive.

529 Contributions and Medicaid Eligibility

When grandparents make gifts to 529 accounts, or any other gifts, whether to family members or to charities, it’s important to keep Medicaid eligibility requirements in mind. Here’s why: Medicaid presumes that all gifts made in the five years prior to filing for Medicaid were made in contemplation of applying for Medicaid. Individuals seeking eligibility for long-term care Medicaid benefits must disclose all gifts made by the individual or his or her spouse within the prior five years.

Does this potential risk of a Medicaid penalty suggest that putting money into a 529 for a grandchild should cease? Not necessarily. For more details about this, please see our resource page, “Medicaid: The Perils of Gifting FAQ.”

Consider Financial Planning and Medicaid Asset Protection Planning with the Farr Law Firm

Whether you’re close to retirement, already retired, employed, or recently unemployed, it is important to protect your quality of life in your golden years with estate planning, long-term care planning, and retirement planning, including setting up trusts for children and grandchildren and discussing Medicaid eligibility.

Besides being a Certified Elder Law Attorney, I am also an experienced retirement planning advisor and long-term care financial advisor through my affiliation with Protection Point Advisors.

Please call us to make an appointment for an initial consultation for Long-Term Care Planning, Estate Planning, Financial Planning, or Incapacity Planning:

Fairfax Elder Law Attorney: 703-691-1888
Fredericksburg Elder Law Attorney: 540-479-1435
Rockville Elder Law Attorney: 301-519-8041
DC Elder Law Attorney: 202-587-2797

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About Evan H Farr, CELA, CAP

Evan H. Farr is a 4-time Best-Selling author in the field of Elder Law and Estate Planning. In addition to being one of approximately 500 Certified Elder Law Attorneys in the Country, Evan is one of approximately 100 members of the Council of Advanced Practitioners of the National Academy of Elder Law Attorneys and is a Charter Member of the Academy of Special Needs Planners.

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