The Grandparent 529 Loophole Is Real

A regulatory change buried in federal financial aid law is handing grandparents one of the strongest college-funding tools in years. It's not exactly new - it took effect with the 2024-2025 FAFSA - but its implications are flying under the radar for most families. Here's the TL;DR: Grandparents can fund a 529 college savings account for a grandchild and pay tuition directly from it with zero impact on that student's financial aid eligibility. Before 2024, that wasn't the case.

Read:Balancing college savings and retirement funds

What changed, and why it matters

For years, grandparent-owned 529 plans carried a hidden tax. The account didn't appear on the Free Application for Federal Student Aid (FAFSA), but when grandparents used the money, the trap sprang shut.

Under the old rules, any distribution from a grandparent-owned 529 was classified as untaxed student income. Colleges used a financial aid formula that counted up to 50% of that amount against the student's aid package. The math was punishing. A $10,000 distribution to cover a grandchild's tuition could reduce need-based financial aid by $5,000. According to Joanne Dashiell, chief marketing officer at CollegeWell, families were penalized for being generous at the wrong time.

The FAFSA Simplification Act changed this scenario. Starting with the 2024-2025 application cycle, you don't have to report distributions from non-parent-owned 529 plans anywhere on the form as assets or income. Dashiell said, "This [update] provides a great opportunity for grandparents to help meet college expenses without impacting the financial aid award."

The mechanism behind the shift is straightforward. The new FAFSA replaces the old manual reporting process by pulling income data directly from federal tax returns through the IRS's FA-DDX system. Since 529 distributions don't appear on a federal tax return, they don't appear on the FAFSA. This policy applies to cash support from any non-parent source, not just grandparents, though the grandparent 529s tend to have the biggest financial impact.

"This [FAFSA update] provides a great opportunity for grandparents to help meet college expenses without impacting the financial aid award."

The CSS Profile caveat

Don't overlook this caveat, because it's an important one.

Approximately 200 to 300 private colleges require the CSS Profile in addition to the FAFSA when awarding institutional aid. This very detailed form asks about grandparent-owned 529 assets and planned distributions. Raymond Tarpley, manager of growth initiatives at the University of Maryland Global Campus, said institutions that use the CSS Profile may still assess these resources, and they don't treat them uniformly.

Dashiell said, "Families should contact colleges that require the CSS Profile to learn how it will factor that information into the financial aid packaging." If a grandchild plans to apply to select private schools, talk to the financial aid office before contributing large sums.

Superfunding

There's another option for grandparents who want to do more than annual gifting: a financial mechanism called superfunding. Few people use it, and it's worth knowing about.

The annual gift tax exclusion in 2026 is $19,000 per person. A grandparent can give $19,000 to a grandchild's 529 this year with no gift tax implications. A couple filing jointly can give $38,000.

Superfunding takes these amounts further. The IRS allows you to front-load five years of annual exclusion gifts into a 529 in one contribution - $95,000 for a single filer and $190,000 for a married couple in 2026. Because the agency treats the contribution as spread over five years, it doesn't trigger gift tax, and the money gets removed from your taxable estate.

According to SavingForCollege, the generation-skipping transfer (GST) lifetime exemption is currently $15 million, so most families won't hit that ceiling. This estate planning makes sense for some, as you can move a substantial sum from your taxable estate while still retaining control of the account. It stays in your name, you choose the investments, and you can change the beneficiary if needed.

Dashiell said, "529 plans are generally excluded from the donor's taxable estate," making them one of the cleaner ways to reduce estate exposure while doing something useful with the money now.

One rule to know: If you superfund a 529, you can't make additional annual-exclusion gifts to that grandchild without sacrificing the exclusion you've already used.

What happens if money goes unused?

The answer got a bit more interesting in 2024. Under SECURE 2.0 (the federal retirement legislation passed in 2022), you can roll unused 2029 funds into a Roth IRA for the account's beneficiary (tax- and penalty-free) starting January 1, 2024.

The 529 must have been open for at least 15 years, and the rollover is subject to annual Roth IRA contribution limits (about $7,500 in 2026). The lifetime cap is $35,000 per beneficiary.

This update considerably changes the downside calculus for 529 plans. The old concern (what if my grandchild gets a scholarship or skips college?) no longer means money is trapped. It can become a head start on retirement savings instead.

The rollover must go into a Roth IRA held in the beneficiary's name, and the beneficiary must have earned income at least equal to the rollover amount for that year.

A few practical notes

If you have multiple grandchildren, federal rules require a separate 529 account for each. You can change beneficiaries between accounts if one grandchild doesn't use their full balance.

Dashiell said, "The best way to pay for college costs is to save for college - the earlier, the better." Even modest contributions made early have years to compound before a grandchild reaches college age.

Over 30 states offer a state income tax deduction for 529 contributions, although amounts and eligibility rules vary considerably. Check your specific state - and note that most states only extend the deduction when you use your home state's plan.

A final caveat: Tax laws, gift exclusion amounts, and financial aid rules can change. All numbers in this article reflect 2026 figures, and you should verify them with a financial advisor or CPA before acting on them. Families applying to private colleges that use the CSS Profile should contact those schools' financial aid offices directly.

This article written for TheStreet by Nifty 50+

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This story was originally published July 15, 2026 at 9:37 AM.