A grandparent-owned 529 plan is not reported as an asset on the Free Application for Federal Student Aid (FAFSA), but distributions count as untaxed income to the beneficiary on a subsequent year's FAFSA. This reduces eligibility for need-based financial aid by as much as half of the distribution amount.
This is in contrast to a parent-owned 529 plan, which is reported as an asset on the FAFSA, but distributions are ignored. Parent assets reduce aid eligibility by up to 5.64% of the asset value.
There are a few potential workarounds for a grandparent-owned 529 plan:
- Delay taking a distribution until January 1 of the student's sophomore year in college. If the student will graduate in four years, there will be no subsequent year's FAFSA to be affected, since the FAFSA bases income on the prior-prior year.
- Change the account owner from the grandparent to the parent.
- Rollover a year's worth of money each year from the grandparent-owned 529 plan to a parent-owned 529 plan after filing the FAFSA. The parent-owned 529 plan must be in the same state as the grandparent-owned 529 plan to avoid state tax benefit recapture rules and state income taxes, since most states consider an out-of-state rollover to be a non-qualified distribution.