A 529 plan can be a great way to save for your grandkids’ college education, and they are now easier to use in concert with financial aid. Thanks to the FAFSA Simplification Act, the notoriously frustrating process of applying for student aid has been streamlined. The simplification act removed over two-thirds of the questions on the FAFSA form. Best yet, the FAFSA now lets grandparents with 529 accounts take advantage of the “grandparent loophole" to fund a child's education without derailing their financial aid application.
But are you taking advantage of this powerful back-to-school savings strategy? According to a study from Edward Jones, half of Americans don’t know what a 529 plan is and fewer than a quarter have one. If you're one of these individuals, you could be missing out on several benefits, including tax-free growth, the opportunity to roll over unused funds into a Roth IRA and the ability to use the grandparent loophole to fund a grandchild’s education without impacting their financial aid eligibility.
529 grandparent loophole
529 plans allow a contributor to prepay a beneficiary's qualified higher education expenses at an eligible educational institution or to contribute to an account for paying those expenses. While 529 contributions have to be made with after-federal-tax money, the contributions grow free from federal or state tax.
Previously, distributions from a grandparent’s 529 plan were reported as untaxed student income, which could reduce aid eligibility by up to 50% of the distribution amount — a significant penalty. For example, under the old rules, a $10,000 529 plan distribution could reduce your grandchild’s aid eligibility by $5,000.
However, with the new streamlined FAFSA (which started with the 2024–25 award year), there’s now a difference in how distributions are treated compared to previous years, giving grandparents a positive advantage.
On the 2024-25 FAFSA, students are no longer required to report cash gifts from a grandparent or contributions from a grandparent-owned 529 savings plan. Because of this, grandparents can now use a 529 plan to fund a grandchild’s education without impacting their financial aid eligibility.
In fact, with the new FAFSA form, a student’s total income is only based on data from federal income tax returns via the IRS. Therefore, any cash support, no matter the source, will not negatively impact financial aid eligibility on the FAFSA. However, at over 200 private institutions that use the CSS Profile for awarding their own financial aid, grandparent-held 529 plans will still be considered.
Additionally, 529 plans are subject to gift taxes when they exceed certain thresholds. For 2024, the annual gift tax limit is $18,000 or $36,000 for married couples. In 2025, the annual gift tax limit is $19,000 or $38,000 for married couples filing jointly. These limits apply to each person who is receiving a gift in a year. This means that you can donate up to $18,000 ($19,000 in 2025) or $36,000 ($38,000 in 2025) per grandchild each year without owing a federal gift tax.
Tax-free rollovers to Roth IRAs
If you put money in a 529 for your grandchild and they ended up not going to college or only spent a portion of what you saved, you can roll over funds from your 529 plan tax-free into a Roth IRA, as long as certain conditions are met. Rolling over unused funds from a 529 account into a Roth IRA can help individuals avoid tax penalties that occur when withdrawing funds for non-education expenses.
Keep in mind that there is a limit on how much money can be rolled over — over the course of the beneficiary's lifetime. And these rollovers are subject to Roth IRA annual contribution limits. IRA contribution limits for the 2024 tax year are $7,000 for people under 50 and $8,000 for people 50 and older. These amounts remain the same for 2025.
There are also several other limitations you should be aware of:
- Your 529 savings account must be open for over 15 years before funds can be rolled over into a Roth IRA.
- If the 529 beneficiary is different from the 529 holder, the Roth IRA must be in the beneficiary’s name.
- 529 contributions made within the preceding five years cannot be rolled over.
- The beneficiary must have earned income for the year at least equal in amount to the Roth IRA contribution transferred from the 529 account.
