FAFSA Changes: Good News for Grandparent 529 Plans

October 8, 2021: By Matthew Okaty: 

If you have ever filled out a federal student financial aid application (FAFSA) before, whether as the parent or the student applicant, then you know how cumbersome and daunting the process can be.  At over 100 questions long, the application seems to request every piece of information about you and your family’s financial situation except for perhaps how many pennies you collected while walking down the street.  Fortunately, that should change with the passage of the FAFSA Simplification Act as part of the Consolidated Appropriations Act of 2021.  In addition to shortening the application significantly (the new application is estimated to have only about 36 questions), the act expands federal aid eligibility to more students, particularly for Pell Grant awards, and includes a number of other provisions to streamline the overall process and make it more accessible.     

While not necessarily highlighted in the act, 529 College Savings accounts will also receive more favorable treatment as a result of the changes.  Currently, distributions from a 529 account owned by anyone other than the student’s parents (such as a grandparent) are considered untaxed student income (question 44i on the current FAFSA form), even if it is used for qualified education expenses.  This has the unfortunate effect of decreasing the amount of financial aid awarded to the student by up to 50% of the amount received from the 529 account.  So, for example, if a grandparent uses $10,000 from their 529 account to help pay for school, the student will generally receive $5,000 less in financial aid the subsequent year.   While there are strategies for minimizing the financial impact or avoiding it altogether, such as transferring ownership of the account to the parents or getting creative with the timing of disbursements, this has always seemed like an unfair double-edged sword.  Once the new FAFSA changes go into effect, though, students will no longer be penalized for receiving such assistance from grandparents or other relatives.  That’s because the definition of “untaxed income” will be narrowed and all income sources will be derived from the student’s federal tax return (if filling out the FAFSA online, the income data can be pulled directly from the IRS electronically).  

It is important to note, however, that colleges and universities have their own questionnaire and set of criteria (the College Board’s CSS Profile) for awarding institutional and private aid.  Thus, the FAFSA changes discussed above will only have an impact on federal aid.  Also, families will have to wait a little bit longer to benefit from these changes, as the full rollout of the new provisions has been delayed.  The new FAFSA application was originally scheduled to become available on October 1, 2022 for the 2023—2024 school year, but full implementation will be difficult to achieve under that timeline and so the government will instead be using a phased approach that will extend to the 2024-2025 award year.    

Navigating the financial aid process and trying to maximize one’s resources to pay for college can be quite complicated.  If you feel overwhelmed or have any questions, please do not hesitate to reach out to us for assistance.