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New Saving Incentive for Grandparent-Owned 529 Plans

The Consolidated Appropriations Act has made it easier for grandparents to save money for grandkids in an employer-sponsored 529 plan — starting with the 2023-2024 academic year.

A 529 plan is a tax-advantaged employer-offered savings account employees can use to save for Kindergarten through grade 12 tuition, or for higher education and trade schools for themselves or a child. The funds typically are invested in stock and bond funds and 529 account owners don’t have to pay capital gains taxes on earnings when withdrawn for qualified education expenses.

Saving for college has become an imperative for many families as parents have taken on more than $100 billion of the $1.7 trillion U.S. student debt, according to Saving, the U.S. Federal Reserve and the Federal Reserve Bank of New York. To help their children with college costs, many parents have taken out equity loans or reduced their 401(k) contributions. For these reasons grandparents have become interested in helping their grandchildren save for college through a 529 plan.

The 529 plans were created in the late 1990s to help parents. In 2019, the SECURE Act made it possible for families to also use the plans to pay K-12 tuition for their children, as well as for apprenticeships, college, and trade schools and to pay for student loans.

Another big change came in 2021, when the Consolidated Appropriations Act called for changes to the Free Application for Federal Student Aid (FAFSA) process. It was assumed the changes would happen soon after, but the Department of Education announced in June 2021 that the proposed FAFSA simplification changes will be delayed. Instead, the provisions will happen in phases beginning in 2021 and lasting through 2025. A new FAFSA form that allows for changes affecting grandparents’ contributions will not be released until October 1, 2022, for the 2023-2024 academic year.

That means that grandparent 529 plan distributions — as well as contributions made by non-custodial parents and friends — currently may count as untaxed income on a student’s FAFSA. For instance, a grandparent who takes a $10,000 529 plan distribution to help pay for college can reduce their grandchild’s aid eligibility by $5,000.

Generally, though, 529 plans have a minimal effect on financial aid. For instance, FAFSA ignores distributions from a parent-owned 529 plan.

Employer Contributions

Employers can make matching contributions, but these contributions will increase an employee’s taxable wages. Still, many employees perceive this as free money and participation in a 529 usually increases when employers offer matching contributions. In addition, while contributions to a 529 plan are not deductible at the federal level, more than 30 states offer a tax deduction or credit for contributions.

There are some administrative complexities to consider. For instance, with some traditional state-sponsored 529 plans, an employee who wants to change a contribution usually has to log into the state-run 529 site, change their monthly contribution, print out a form, and give that form to their benefits administrator. The benefits administrator must manually adjust the employee’s payroll deduction in their payroll software.

There are options, so it pays to do your research. Some companies, such as financial technology firms, offer 529 plans that integrate with state-run 529 plans and offer a simplified user and enrollment experience.