We are often asked how grandparents can help fund education costs for their grandchildren. We all know that education costs are rising at a mind-boggling rate, and clients often want to lend a hand so their grandkids are not saddled with mounds of student debt upon graduation. 529 College Savings Plans have long been excellent tools to help with the high costs of education, but recent changes have made these accounts even more attractive planning tools to both help grandchildren and potentially reduce the grandparents’ tax bill.
Until recently, the method by which the Free Application for Federal Student Aid (FAFSA) counts assets has presented a challenge when grandparents funded 529 plans. FAFSA is the form all students complete to apply for student aid. Under present law, assets owned by a custodial parent or a dependent student reduce the eligibility for needs-based aid by as much as 5.64% of the value of the account. Distributions from these accounts are not considered income on the FAFSA. If a 529 plan is owned by anyone else (like a grandparent) it is not reported as an asset on the FAFSA. However, in this case any distributions are reported on the FAFSA as untaxed income to the student. Student income can reduce eligibility for needs-based aid by as much as 50% of the distribution.
For this reason, a common recommendation was for grandparents to fund 529 College Savings Plans with the goal of using those assets for the last two years of tuition. Because the financial information requested by FAFSA is from two years prior, funds used to pay tuition after January 1st of the student’s junior year will never show up on a FAFSA. If the funds were used at the beginning of the junior year, they would only affect eligibility for the senior year.
However, the Consolidated Appropriations Act of 2021 has mandated a simplification of the FAFSA by removing most of the questions asked, including the one that asks about cash gifts from others. Under the new rules, all student income information will come directly from the student’s own tax return, which does not show grandparent distributions paid directly to institutions.
It is important to note the Department of Education has not issued any guidance on the new simplified FAFSA, and the new form is not expected to be available until October of 2022. But because of the two-year delay in income reporting, it does appear that grandparents can begin paying tuition now with no adverse effects on eligibility for student aid. It also should be noted that some schools, mostly private universities, use a different form, called the CSS Profile. The CSS Profile asks many more questions than even the current FAFSA and does have a question about grandparent-owned 529 plans. It is possible that more schools will adopt the CSS Profile in the future to gain a more complete picture of a student’s ability to pay tuition.
529 plans also make great tools to reduce the value of your estate. As the Biden administration looks to reduce the estate tax exclusion, more estates will find they owe taxes. Under present law, estates of single filers can exclude up to $11,700,000 from federal estate taxes and married couples can double that amount. According to The Tax Policy Center, only .01% of estates paid any estate taxes at all in 2020. While I can’t predict by how much the estate tax exclusion will decrease, my guess is that it will come down significantly. Lifetime gifting exemptions are currently tied to the estate tax exclusion, meaning anyone can gift $11,700,000 without triggering a tax bill. You will need to file a gift tax return, but today’s favorable tax laws may make gifting to a 529 plan a good strategy to reduce the value of your estate. Changes to distribution rules contained in 2017’s Tax Cuts and Jobs Act may make this especially attractive, since up to $10,000 per year can be withdrawn from 529 plans to cover private K-12 tuition. Of course, you should always consult your tax professional and estate planning attorney before making any large transfers.
There is a lot to know about 529 plans. If you would like to discuss your wishes and determine whether a 529 can help you and your family reach your goals, please reach out to your advisor. We are always happy to talk with you.
Howard Pressman, CFP®
Before investing, the investor should consider whether the investor’s or beneficiary’s home state offers any state tax or other benefits available only from that state’s 529 Plan.