Sending a loved one to college is an emotional and memorable experience. Unfortunately, this moment often comes with a significant financial commitment. The good news is there are various instruments and strategies to help families save and pay for college while assisting in the financial aid process.

One of the best tools for determining eligibility is the FAFSA (Free Application for Federal Student Aid). Understanding the ins and outs of the FAFSA can be daunting, yet it’s vital to fully understand what counts toward federal aid eligibility.

When it comes to aid eligibility, there is a lesser-known rule that can drastically impact a family’s financial aid eligibility called the grandparent rule. In this blog post, we dive into the FAFSA, the 529 college savings plan, and the inner workings of the grandparent rule.

Understanding the FAFSA

The FAFSA is an important step for college-bound students seeking financial aid. Universities and colleges use this form to help determine federal student aid program eligibility. The FAFSA is essential for accessing things such as scholarships, grants, and loans.

There are a few things to remember when dealing with the FAFSA:

Status: A student will be characterized as dependent or independent. A vast majority will qualify as dependent students and must provide their personal information along with their parents’ information. On the other hand, independent students will only report their own information (and spouse’s, if married). In most cases, independent students will receive more financial aid. The dependency status is based on several factors, which can be found here.
Financial information: The student is required to provide information on their and their family’s income and assets. This information helps determine the Student Aid Index (SAI), the main input in determining federal financial aid calculations.
Tax benefits: Often overlooked is the impact certain tax benefits may have on the income the student reports on the FAFSA. Things such as the American Opportunity Credit (AOC) or the Lifetime Learning Credit (LLC) may impact eligibility for need-based financial aid.

529 College Savings Plans

Funding a 529 plan is one of the most common strategies family members use for future education expenses. For a refresher on 529s, please refer to my blog post on this very topic.

While 529 plans provide a litany of benefits, mainly being tax-free if used for qualified higher education expenses, their impact on FAFSA eligibility varies depending on the account owner. Generally speaking, they have a minimal impact on aid eligibility, but families need to be certain before they act.

The account owner of a 529 is typically a parent or grandparent, and they maintain control over the account, with the student listed as the beneficiary. If a parent is listed, the funds are considered a parental asset on the FAFSA, which is more advantageous than having the student be listed as the account owner.

While it’s beneficial to have the asset listed under the parent’s name over the student’s, there is another option. This option is called the grandparent rule.

Grandparent Rule

Thanks to a recent rule change, students will no longer be required to report cash funding for college when applying for aid. This is good news for grandparent-owned 529s, as these funds will not count as untaxed student income when it comes to student financial aid eligibility. This new rule goes into effect for the 2023-2024 school year.

It’s important to remember that the annual gift limit in 2023 is $17,000. This means any individual can contribute up to this amount in a single 529 plan without it counting against their lifetime gift tax exemption. You can also look into superfunding a 529, which allows for up to five years’ worth of gift tax returns in a single year.

Also, some states provide larger tax benefits upon making a 529 savings plan contribution. This gives grandparents another incentive to help save toward their grandchildren’s education goals.

While this change is welcomed for those seeking FAFSA aid eligibility, the change did not impact the College Scholarship Service (CSS). The CSS Profile is an online application created by the U.S. College Board that allows students to apply for non-federal financial aid. Click here to see a list of schools that fall under the CSS Profile.

Bottom Line

There are many ways to save for education, and unfortunately, there is no one-size-fits-all strategy. While the change in the grandparent rule is welcomed, it does not necessitate immediate action for most.

In the end, not every student will qualify with the FAFSA. For those who do, a maximum of 5.64% of parental assets is counted in determining the Student Aid Index (SAI), compared to 20% of assets in the student’s name.

Ultimately, avoiding assets directly in the student’s name is a good idea if looking to qualify for some level of financial aid. Like most financial decisions, this should be reviewed case by case to determine the best course of action.

Discuss your situation with a fee-only financial advisor.