For years, families with generous grandparents faced an unexpected problem when saving for college. While 529 plans were designed to encourage families to save for education, grandparent-owned 529 plans often ended up hurting a student’s eligibility for need-based financial aid. As a result, many families delayed using those funds or avoided them altogether.
That dynamic has now changed. Thanks to recent FAFSA updates, the so-called 529 grandparent loophole has become a powerful—and completely legal—strategy for families who want to work together across generations to pay for college without sacrificing financial aid.
At College Benefits Research Group (CBRG), we help families understand how this change works, what it does and does not affect, and how to use grandparent-owned 529 plans strategically as part of a broader college funding plan.
How 529 Plans Fit into College Funding Strategies
A 529 plan is a tax-advantaged savings account designed specifically for education expenses. Contributions grow tax-deferred, and withdrawals are tax-free when used for qualified education costs such as tuition, fees, books, and in some cases housing.
One of the most flexible aspects of 529 plans is ownership. Parents, grandparents, other relatives, and even family friends can open and fund a 529 for the same student beneficiary. However, ownership matters greatly when it comes to financial aid.
Parent-owned 529 plans are treated as a parent asset on the FAFSA and assessed at a relatively low rate. Grandparent-owned 529 plans, on the other hand, historically created complications—not because of the account itself, but because of how withdrawals were reported.
Understanding where 529 plans fit into both college savings and financial aid strategy is critical. This is especially true for families who expect to qualify for need-based aid and who rely on multiple contributors to fund college costs.
The Original Problem With Grandparent-Owned 529 Plans
Under the old FAFSA rules, grandparent-owned 529 plans were not reported as assets—which initially seemed like a good thing. The issue arose when the funds were actually used.
When grandparents took money out of their 529 plan to pay for a student’s education, those distributions were counted as untaxed student income on the following year’s FAFSA. Student income is assessed at a much higher rate than parent assets, often reducing need-based aid eligibility by as much as 50% of the amount withdrawn.
This meant a $10,000 529 withdrawal could reduce financial aid eligibility by up to $5,000 the next year. Families who weren’t aware of this rule were often surprised when aid packages dropped after a grandparent helped pay tuition.
As a result, families adopted workarounds—such as waiting until senior year to use grandparent funds or transferring ownership of the 529 plan to a parent. While legal, these strategies were imperfect and often limited flexibility.
FAFSA Simplification and the End of the Old Penalty
The FAFSA Simplification Act dramatically changed how financial aid eligibility is calculated, including how outside financial support is treated.
One of the most important FAFSA changes was the removal of the FAFSA question that asked students to report cash support and other untaxed income. This question was the mechanism that caused grandparent 529 distributions to reduce aid eligibility.
With that question eliminated, distributions from a grandparent-owned 529 plan are no longer reported on the FAFSA at all. That means:
- Grandparent 529 plans still do not count as assets
- Withdrawals from those plans no longer count as student income
- Need-based aid eligibility is no longer reduced as a result
This change is what families now refer to as the 529 grandparent loophole. While it may sound like a workaround, it is simply the result of updated FAFSA rules—and it is fully compliant with federal financial aid policy.
What the 529 Grandparent Loophole Really Means for Families
The impact of this change is significant. Families no longer need to delay using grandparent funds or worry about unintended aid consequences.
Grandparents can now:
- Pay tuition directly from their own 529 plan
- Help cover room and board or other qualified expenses
- Provide support in any year of college—not just senior year
For families who qualify for Pell Grants, state aid, or institutional need-based grants, this coordination can preserve tens of thousands of dollars in aid over four years.
This strategy is especially valuable for middle-income families who are often squeezed between high college costs and limited aid eligibility. When used correctly, the grandparent loophole allows families to reduce out-of-pocket expenses without sacrificing financial aid.
Strategic Ways Families Can Use the 529 Grandparent Loophole
With the penalty removed, families have more flexibility—but strategy still matters.
Common approaches include:
- Using parent-owned 529 plans first, while reserving grandparent funds for later years
- Coordinating withdrawals after financial aid packages are finalized
- Assigning grandparents to cover specific expenses, such as housing or tuition gaps
Poor coordination can still create issues, particularly if families misunderstand what counts as a qualified expense or fail to align 529 withdrawals with institutional billing schedules.
CBRG works with families to ensure 529 strategies align with FAFSA timing, college policies, and overall affordability goals.
What Has Not Changed: Rules Families Still Need to Follow
While the FAFSA treatment has changed, not everything about grandparent 529 plans is different.
Important considerations still include:
- Withdrawals must be used for qualified education expenses to remain tax-free
- Some private colleges use the CSS Profile, which may still consider outside support differently
- Institutional aid formulas can vary by school
- State-specific tax rules may still apply to contributions and withdrawals
Families attending private colleges or highly selective institutions should be especially careful. Even if the FAFSA no longer penalizes grandparent support, institutional methodology may still require disclosure.
How CBRG Helps Families Use the 529 Grandparent Loophole Correctly
The 529 grandparent loophole is powerful—but only when used as part of a coordinated plan.
CBRG helps families:
- Align parent and grandparent 529 strategies
- Coordinate FAFSA and CSS Profile reporting
- Determine optimal withdrawal timing
- Avoid missteps that could impact institutional aid
- Build multi-year college funding plans that reduce debt
Our advisors routinely work with families where grandparents want to help but don’t want to jeopardize aid. With proper planning, both goals can be achieved.
Frequently Asked Questions About the 529 Grandparent Loophole
It applies to FAFSA-based aid. Some private colleges using the CSS Profile may still treat outside support differently.
Not on the FAFSA. However, institutional aid forms may still ask about outside assistance.
They can, but direct payments may still affect institutional aid. Using a 529 is usually more tax-efficient.
Not necessarily. In many cases, keeping the plan in the grandparent’s name is now advantageous.
No. Merit aid is not based on financial need and is generally unaffected by 529 ownership.
Yes. Multiple 529 plans can exist for one beneficiary, but coordination is important.
Misreporting assets, misunderstanding CSS Profile rules, or using funds for non-qualified expenses can still cause problems.
Understanding the 529 grandparent loophole gives families a rare opportunity to improve affordability without sacrificing aid. With the right guidance, it can be one of the most effective tools in a multi-generational college funding strategy.