What is FAFSA?

To determine eligibility for federal student aid (grants, work­study, loans, etc.) current and future college students in the U.S. prepare a FAFSA (the Free Application for Federal Student Aid) application. The application takes into account how much a student and his or her family can afford to contribute toward the estimated cost of attendance (i.e., tuition). The “expected family contribution” is established by taking the income and assets of the parents, along with the income and assets of the student, and plugging these numbers into the application’s formula to determine how much a family can afford to pay.

Grandparent­funded 529 plans and FAFSA

Anyone, including grandparents, can open and fund a 529 college savings plan by gifting up to the amount of the annual exclusion, currently $14,000, or five times that amount, which will count as an annual exclusion gift over five years. An advantage for a grandparent is they can be sure that the money will be used for educational purposes since the owner of a 529 plan retains control over the plan. The existence of the 529 plan will not impact the FAFSA applications, but distributions from the plan, including qualified education expenses of a grandchild, however, can have a negative impact on FAFSA.

Distributions from a grandparent­owned 529 plan are considered untaxed income that historically was added to the student’s adjusted gross income and reportable on the following year’s FAFSA. This can have a negative impact on financial aid as student income is assessed at 50% of the student’s income over the income allowance, currently $6,260. For example, if a grandparent distributes $10,000 from the plan to cover college costs, it could reduce the student’s eligibility for aid the next year by $5,000.

Beginning with the 2017–2018 school year, the FAFSA application will look to the prior­prior year for income, where it originally only looked to the prior year for income. What this essentially means is income (and assets) from the second half of sophomore year in high school through the first half of sophomore year of college will have an impact on financial aid. Accordingly, distributions from a grandparent­ funded 529 plan after a student is halfway through his sophomore year in college will have no impact on FAFSA income. Additionally, in the last two years of college, a grandparent could consider directly paying college tuition or gifting appreciated assets to a grandchild to sell, which would be taxed at the grandchildren’s lower capital gains tax rate.