With future FAFSA forms now using tax returns from two years prior (known as “prior prior” in the college world), that adds another year that family members can help pay for college without it negatively affecting financial aid eligibility.
First, some quick background: The three main factors used to calculate financial aid eligibility are
- Non-retirement assets in the student’s name
- Non-retirement assets in the parent’s name (also excluding home value of the primary residence)
- Number of other children in college
So while assets held in grandparent-owned 529s aren’t counted in the formula above, any amounts withdrawn from these accounts to help pay college costs must be reported as income for the grandchild. And that added income can have a big influence on FAFSA calculations since it is assessed at 50%.
As an example, if grandparents contribute $10,000 from their 529 to help with tuition, they could reduce their grandchild’s eligibility for the following year’s financial aid by $5,000. That can be a major mistake if the grandchild could have otherwise qualified for aid.
The way to avoid this dilemma is have grandparents delay tapping into the accounts until the final year of college and after the last FAFSA has been filed so it does not show up as student income.
The challenge, though, is that it doesn’t leave much time to help pay for college expenses and depending on how much a grandparent has in the 529, may not allow them to use the entire amount.
New rule provides a second year of penalty-free funding
The big change is that beginning with the 2017–2018 school year, families filing the FAFSA will report income from two years prior instead of one.
Students graduating in the spring of 2016 reported income from 2015 on their FAFSA. But students graduating in spring 2017 will also report income from 2015 on their FAFSA (but not also 2016), meaning the look-back period moved from one year to two, as it will continue for each subsequent graduating class.
So why is this change important for grandparents? Because now they can start paying for college expenses from their 529 plans in the year in which their grandchild becomes a junior, a year earlier, without harming financial aid opportunities.