Just as in previous years, 529s must be in the name of a student or their parents for the plan distributions to be exempted as “income” on the FAFSA, while distributions from 529s in the names of other relatives—like grandparents—must be reported as income.
However, because the FAFSA’s income estimate now looks back two years instead of using the prior year’s income, students can take those distributions during their penultimate and final years in college without impacting their aid eligibility.
“We’re suggesting that people use their 529s that are in the parents’ or the student’s names during the freshman and sophomore years, and then if there are any grandparent 529s, use them in the junior and senior years,” Sommer says. “It will no longer show up as income at that point. The rule change ends up increasing the flexibility of 529s.”
The tax rules for tuition “gifts” directly to higher education institutions from grandparents and other relatives have changed as well. Now individuals can gift unlimited amounts directly to a university without triggering a gift tax. This offers high-net-worth grandparents a useful way to deploy their wealth and reduce their potential estate tax burden.
Sommer says that the rule changes will have residual impacts on higher-net-worth families whose children won’t typically qualify directly for federal student aid.
“Many schools are adjusting their financial aid program to be harmonized with the new October 1 window,” Sommer says. “In a lot of cases, school aid from a particular college and university are limited funds, doled out on a first-come, first-serve basis. It’s important for families who may not qualify for federal aid but may qualify for school aid or have a student that qualifies for scholarships to comply with the new deadline. File ASAP because you don’t want to lose your place in line.”