Kathryn Pomroy
A 529 plan can be a great way to save for your grandkids’ college education, and it is now easier to use in concert with financial aid. Thanks to the FAFSA Simplification Act, the notoriously frustrating process of applying for student aid has been streamlined. The simplification act removed over two-thirds of the questions on the FAFSA form. Best yet, the FAFSA now lets grandparents with 529 accounts take advantage of the “grandparent loophole" to fund a child's education without derailing their financial aid application.
But are you taking advantage of this powerful back-to-school savings strategy? Recent data from a 2025 Edward Jones survey shows a slight increase in unawareness from 2024, with 52% of Americans saying they are unfamiliar with 529 plans. Because many people are not aware that 529 plans exist, only 14% of survey respondents currently use or intend to use a 529 plan for education savings.
Unfortunately, as so many people don't know about these tax-advantaged savings options, it can hinder both college plans and bigger financial dreams down the road. The benefits you're missing out on include tax-free growth and the opportunity to roll over unused funds into a Roth IRA.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
You could also be missing out on the grandparent loophole to fund a grandchild’s education without impacting their financial aid eligibility.
529 grandparent loophole
So what is the grandparent loophole, and how can it benefit both you and your grandchildren?
529 plans allow a contributor to prepay a beneficiary's qualified higher education expenses at an eligible educational institution or to contribute to an account for paying those expenses. While 529 contributions have to be made with after-tax money, the contributions grow free from federal or state tax.
Previously, distributions from a grandparent’s 529 plan were reported as untaxed student income, which could reduce your eligibility for aid by up to 50% of the distribution amount — a significant penalty. That means, under the old rules, a $10,000 529 plan distribution could reduce your grandchild’s aid eligibility by $5,000.
The good news is that with the new streamlined FAFSA (which took effect starting with the 2024-2025 award year), there’s now a difference in how distributions are treated compared to previous years, giving grandparents a welcome advantage.
On the 2026-2027 FAFSA, students are not required to report cash gifts from a grandparent or contributions from a grandparent-owned 529 savings plan. Because of this, grandparents can now use a 529 plan to fund a grandchild’s education without impacting that grandchild's financial aid eligibility.
With the new FAFSA form, a student’s total income is only based on data from federal income tax returns from the IRS. Therefore, any cash support, no matter the source, will not negatively impact financial aid eligibility on the FAFSA.
Instead of the more common FAFSA, more than 200+ private institutions use the CSS Profile for awarding their financial aid. These plans take a more complete picture of your financial circumstances than the FAFSA does, and grandparent-held 529 plans will still be considered.
Additionally, 529 plans are subject to gift taxes when they exceed certain thresholds. For 2025, the annual gift tax limit is $19,000 (up from $18,000 in 2024) or $38,000 (up from $36,000 in 2024) for married couples filing jointly. These limits apply to each person who is receiving a gift in a year. This means that you can donate up to $19,000 (or $38,000) in 2025 per grandchild each year without owing federal gift tax.
Tax-free rollovers to Roth IRAs
If you put money in a 529 for your grandchild and they ended up not going to college or only spent a portion of what you saved, you can roll over funds from your 529 plan tax-free into a Roth IRA, as long as certain conditions are met. Rolling over unused funds from a 529 account into a Roth IRA can help individuals avoid tax penalties that occur when withdrawing funds for non-education expenses.
Keep in mind that there is a limit on how much money can be rolled over throughout the beneficiary's lifetime. And these rollovers are subject to Roth IRA annual contribution limits. IRA contribution limits for the 2025 tax year are $7,000 for people under 50 and $8,000 for people 50 and older — the same as in 2024.
There are also several other limitations you should be aware of:
- Your 529 savings account must be open for over 15 years before funds can be rolled over into a Roth IRA.
- If the 529 beneficiary is different from the 529 holder, the Roth IRA must be in the beneficiary’s name.
- 529 contributions made within the preceding five years cannot be rolled over.
- The beneficiary must have earned income for the year at least equal in amount to the Roth IRA contribution transferred from the 529 account.
Related Content
-
AI Is Missing the Wisdom of Older Adults: What It Means for YouAI will increasingly affect your healthcare and finances, but young workers are primarily designing the systems and getting most of the jobs.
-
The Three C's to Financial Success: A Financial Planner's Guide to Build WealthConsistency, commitment and confidence in your chosen strategy are more critical to your financial success than finding the 'perfect' financial plan.
