But what many families may not understand fully is how their 529 assets affect their “expected family contribution” (EFC).
Grandparents’ 529 Plan Rules
Know your EFC
Your EFC is the dollar amount generated when you fill out the Free Application for Federal Student Aid (FAFSA).
It’s the amount the federal government says your family can contribute to college costs. It’s based on your income and assets, and it’s usually an uncomfortably high amount for families, and it doesn’t necessarily reflect the true cost of a college to you.
Many colleges aren’t able to cover the difference between sticker price and your EFC, so they may charge you even more.
But it’s possible to lower your EFC come FAFSA-filing time if you’re strategic about where you save your 529 money.
If you save 75 percent in the parents’ name and 25 percent under a grandparent’s name, you can minimize the effect of assets on your EFC.
The FAFSA only asks for assets listed in the parents’ and student’s names. It does not ask for assets saved by a grandparent in a 529 plan.
Doesn’t hold for profile schools
It’s very important to understand that if your child is applying to a selective college that uses the CSS Profile in addition to the FAFSA—the Ivies and liberal arts colleges such as Bowdoin, Carlton, or Colorado College (some 280 institutions)—assets sheltered in a grandparent’s name must be reported. So, in that case, you’ll be out of luck.
The Profile asks many more questions than the FAFSA, and it’s very difficult to tinker with your assets to change your EFC. (It’s worth noting that more families qualify for financial aid at private colleges.)
Grandparent 529 Benefits
For students applying to FAFSA-only schools—the vast majority of colleges—it can pay to put money in a grandparent’s 529 plan.
The trick, however, is to use the funds to pay for college at the right time. If you use grandparent 529 money to pay for your child’s freshman fees, the withdrawn 529 funds must be reported as student income on the sophomore-year FAFSA.
Student income is assessed at 50 percent in the EFC calculation, and can raise a family EFC significantly, compared to parent assets calculated at 5.6 percent.
If your student doesn’t need the money from grandparents for the first two years of college, a good strategy to follow is to use parent 529 funds for the first two years of college, drawing down parent assets, and grandparent funds during the junior and senior years, because by then, the distribution won’t count toward and inflate an EFC calculation.
Effects of FAFSA Timeline on 529 Distributions
The FAFSA opens on October 1. Families will use “prior-prior-year” tax forms, which means you’ll use your 2020 tax return to fill out the FAFSA for 2022 financial aid. You’ll also be able to use the IRS Data Retrieval tool for easy population of numbers.
Grandparent 529s can now be used for the junior and senior year because your sophomore year income is what you will report for the senior-year FAFSA.
Thus, grandparent 529 funds can be used to pay for junior and senior year college fees without negatively affecting the senior EFC—unless your child is headed into a fifth year.
Gifting College Money From Grandparents to Parents
Another option grandparents can consider when helping to pay for college is to gift money to parents.
As of 2018, each grandparent can gift up to $15,000 to each parent. That’s a total of $60,000 per year that can be gifted from grandparents to parents without triggering gift taxes. The parent(s) can then in turn use that money to pay college costs.
In order to not impact any financial aid eligibility, timing for this type of gifting is critical. It’s best for grandparents to gift money to parents AFTER FAFSA has been filed.
Parent and student assets must be reported as of the day FAFSA is filed.
If grandparents gift money after FAFSA is filed, and parents then use the money to pay for college costs before the next FAFSA is filed, the money will not impact the family’s EFC and financial aid eligibility.
Things get trickier if your student is applying to schools that use the CSS Profile.
Though gifts made to parents are not considered income on FAFSA, they are considered income when filling out the CSS Profile.
Of course if parents have a high enough income/assets that your EFC is higher than the cost of your child’s college and you don’t qualify for any need-based aid, you don’t need to be concerned with any of the options discussed above.
But it does pay to fill out FAFSA anyway, because institutions use it to calculate all manner of grants and scholarships, even merit scholarships. So don’t get burned by not filling it out.
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