The “Grandparent Loophole” and Other Reasons for Grandparents to Fund 529 Plans
A 529 Plan, also referred to as a Qualified Tuition Program, is a tax-advantaged way to save for a loved one’s education expenses. While contributions to a 529 Plan are not tax deductible at the federal level, the investments within the plan grow tax-free and withdrawals from the plan are tax-free as long as they are spent on eligible expenses. Traditionally, expenses were deemed eligible only if they were expenses related to college, but since 2017, eligible expenses now include up to $10,000 per beneficiary, per year, for elementary or secondary school tuition.
A question that often arises regarding grandparent-owned 529 Plans is how distributions from those plans affect a grandchild’s financial aid. To understand the impact, one must understand the calculation of the Expected Family Contribution (EFC) as determined upon the completion of the Free Application for Federal Student Aid (FAFSA). Colleges subtract the EFC from their cost of attendance to determine a student’s financial need. The FAFSA looks at assets belonging to both students and their parents as well as income. Colleges will generally expect families to use up to 20% of a dependent student’s assets to pay for college, while 5.64% of a parent’s assets are expected to be used. After deducting amounts for living expenses and tax payments, the FAFSA formula determines the “adjusted available income.” Dependent students are expected to use 50% of their adjusted available income to fund college expenses, and parents are expected to use between 22% and 47% of their adjusted available income.
Therefore, when a parent owns the 529 Plan, 5.64% of the value of the plan is counted towards the EFC. When the student owns the 529 Plan, it is treated as a parental asset for financial aid purposes as long as the student is a dependent. However, until recently, 529 Plans owned by grandparents had a much more detrimental impact on a student’s financial aid. While a 529 Plan owned by a grandparent was not counted as an asset for financial aid purposes, distributions from the plan were treated as income of the student, 50% of which applied to the EFC.
A recent and rather exciting development with regard to 529 Plans is what is being referred to as the “grandparent loophole.” With the overhaul of the FAFSA going into effect for the 2024-2025 school year, distributions from a grandparent-owned 529 Plan will no longer impact a student’s eligibility for financial aid.
Some other benefits of opening and contributing to a 529 Plan for a grandchild include state income tax benefits and estate planning benefits. In Virginia, for taxpayers under 70 years of age, up to $4,000 per account per year are deductible in computing Virginia taxable income, with unlimited carry forward of excess contributions. For taxpayers 70 years of age and older, contributions are fully deductible the first year. As of right now, there is no state tax deduction or credit available for contributions to North Carolina based 529 plans.
From an estate planning perspective, especially as it relates to gift and generation-skipping transfer taxes, contributions to 529 Plans receive special treatment. While an individual can give up to $17,000 per individual per year in traditional cash gifts without any tax consequences, you are allowed to “superfund” a 529 Plan by using five years’ worth of the annual gift-tax exclusion, or $85,000, to make a contribution.
Jennifer S. Rossettini
757-399-7506 | 252-722-2890
Jennifer Rossettini is a Shareholder of Hook Law where she focuses her practice in the areas of elder law, estate planning, estate and trust administration, and financial planning. Her practice includes complex estate planning for clients with a net worth over $5 million as well as simple plans for individuals with very limited assets. Ms. Rossettini rejoined the firm in 2018 after spending ten years as a CERTIFIED FINANCIAL PLANNER™ professional with the wealth management divisions of two regional financial institutions. She is a member of the Financial Planning Association, serving as Secretary for the Hampton Roads chapter and serves on the Board of Directors of the non-profit organization, PrimePlus Senior Centers. Jennifer lives in Virginia Beach with her husband and two daughters. She is active in the Girl Scout organization, serving as both a troop leader and as the treasurer for the local Service Unit.
- Elder Law
- Estate & Trust Administration
- Estate Planning
- Financial Planning