Using a 529 plan can be a great way to save for your grandkids’ college education, and accounts now have an added benefit, thanks to the FAFSA Simplification Act, an overhaul of the processes and systems used to award federal student aid. The simplification, which removed over two-thirds of questions previously asked, lets grandparents with 529 accounts take advantage of what’s called the “grandparent loophole.”
But are you taking advantage of this powerful back-to-school savings strategy? According to astudy from Edward Jones, half of Americans don’t know what a 529 plan is and fewer than a quarter have one. If you're one of these individuals, you could be missing out on several benefits, including tax-free growth, the opportunity to roll over unused funds into a Roth IRA and the ability to use the grandparent loopholeto fund a grandchild’s education without impacting their financial aid eligibility.
529 grandparent loophole
529 plansallow a contributor to prepay a beneficiary's qualified higher education expenses at an eligible educational institution or to contribute to an account for paying those expenses. While 529 contributions have to be made with after-federal-tax money, the contributions grow free from federal or state tax.
Subscribe to Kiplinger’s Personal Finance
Be a smarter, better informed investor.
Save up to 74%
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Previously, distributions from a grandparent’s 529 plan were reported as untaxed student income, which could reduce aid eligibility by up to 50% of the amount of the distribution — a significant penalty. For example, under the old rules, a $10,000 529 plan distribution could reduce your grandchild’s aid eligibility by $5,000.
However, with the new streamlined FAFSA (which starts with the 2024–25 award year) there’s now a difference in how distributions are treated compared to previous years, giving grandparents a positive advantage.
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.
In fact, with the new FAFSA form, a student’s total income is only based on data from federal income tax returns via the IRS. Therefore, any cash support, no matter the source, will not negatively impact financial aid eligibility on the FAFSA. However, at over 200 private institutions that use the CSS Profilefor awarding their own financial aid, grandparent-held 529 plans will still be considered.
Additionally, 529 plans are subject to gift taxes when they exceed certain thresholds. For 2024, the annual gift tax limit is $18,000 or $36,000 for married couples. And this limit applies to each person who is receiving a gift. This means that you can donate up to $18,000 or $36,000 per grandchild each year without owing a federal gift tax.
Tax-free rollovers to Roth IRAs
If you put money in a 529 for your grandchild and they ended up not going to college or only spent a portion of what you saved, you can roll over funds from your 529 plan tax-free into aRoth IRA, as long as certain conditions are met. Rolling over unused funds from a 529 account into a Roth IRA can help individuals avoid tax penalties that occur when withdrawing funds for non-education expenses.
Keep in mind that there is a limit on how much money can be rolled over — $35,000 over the course of the beneficiary's lifetime. And these rollovers are subject to Roth IRA annual contribution limits.IRA contribution limitsfor the 2024 tax year are $7,000 for people under 50 and $8,000 for people 50 and older.
There are also several other limitations you should be aware of:
Your 529 savings account must be open for over 15 years before funds can be rolled over into a Roth IRA.
If the 529 beneficiary is different from the 529 holder, the Roth IRA must be in the beneficiary’s name.
529 contributions made within the preceding five years cannot be rolled over.
The beneficiary must have earned income for the year at least equal in amount to the Roth IRA contribution transferred from the 529 account.
Related Content
529 Plans: Everything You Need to Know About Saving for College
529 Plan Contribution Limits for 2024
How to Open a Roth IRA in 5 Simple Steps
How Estate Planning Can Thwart the ‘Third-Generation Curse’
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
education
onderwyser (plural onderwysers, feminine onderwyseres) teacher (male, or gender neutral)
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.
529 accounts also benefit grandparents because they're incredibly flexible. For example, if the beneficiary decides not to attend college, the account owner can easily change the beneficiary at any time. Equally important is the account owner's ability to transfer ownership.
One issue with 529s has been if the plan is overfunded and the funds remain unused. For families on a tight budget, that creates a difficult choice between saving enough for themselves or providing ample funding for their kids' education.
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.
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.
A 529 plan gives both parents and grandparents the option to contribute to a child's education fund. They have no annual contribution limit and an individual can contribute up to $17,000 per year while avoiding gift tax rules, or $34,000 per couple.
The option is to make a larger 529 plan contribution without affecting your lifetime gift tax exclusion. The IRS allows for a unique strategy known as 5-year gift-tax averaging, which allows a donor to make a larger tax-free contribution to a 529 plan spread evenly over five years.
The Basics. 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.
529 plans do not have specific withdrawal deadlines. A 529 plan account owner is not required to take a distribution when the beneficiary reaches a certain age or within a specified number of years after high school graduation, and funds can remain in the 529 plan account indefinitely.
Under certain conditions, you can roll over tax- and penalty-free up to a lifetime limit of $35,000 in a 529 to a Roth IRA open by the 529 beneficiary for more than 15 years, subject to annual Roth IRA contribution limits. (Note: The annual contribution limit would be the beneficiary's, not the parents'.)
If you use distributions from your 529 account to cover anything other than education costs, you will face a penalty. You will be able to withdraw your money from the account but will be responsible for income taxes on the earnings – federal, state, and county if applicable – as well as a 10% penalty fee.
These plans are attractive for wealthy families because they provide a way for a parent or grandparent to transfer much more money to a child than they would be able to without incurring gift taxes, Stokes says. Here's how he suggests maxing out a 529.
If your child decides not to attend college, the funds can be used at any eligible educational institution offering higher education beyond high school, including some overseas, trade or vocational schools eligible to participate in a student aid program run by the U.S. Department of Education.
There is no annual limit on how much you can withdraw for college expenses, but there are limits on certain expenses. An annual withdrawal limit of $10,000 is applied to 529 plans for K-12 tuition expenses. If you're using 529 plan funds to pay student loan debt, there is a lifetime withdrawal limit of $10,000.
Your 529 can be used for student loan repayment up to a $10,000 lifetime limit per individual. Up to $10,000 annually can be used toward K-12 tuition (per student). You can transfer the funds to another eligible beneficiary, such as another child, a grandchild, yourself or a friend.
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.
Tax advantages. The contributions you make to 529 plans are after-tax, but earnings and withdrawals are federal income tax-free when used for qualified education expenses. ...
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.
One is to transfer or roll over the 529 account to a new beneficiary. To be an income tax-free rollover, that person must be a member of the original beneficiary's family, such as siblings (including stepsiblings), parents, spouse, children, first cousins, nieces and nephews.
Address: 747 Lubowitz Run, Sidmouth, HI 90646-5543
Phone: +99513241752844
Job: Design Supervisor
Hobby: Digital arts, Lacemaking, Air sports, Running, Scouting, Shooting, Puzzles
Introduction: My name is Delena Feil, I am a clean, splendid, calm, fancy, jolly, bright, faithful person who loves writing and wants to share my knowledge and understanding with you.
We notice you're using an ad blocker
Without advertising income, we can't keep making this site awesome for you.
