Here are five things that grandparents (or other relatives and friends) should be aware of when helping to pay for college.
If the student’s family is too affluent to be eligible for need-based financial aid, it doesn’t matter how grandparents save for college or how they help pay the tab.
Grandparent contributions only jeopardize need-based aid. They have no effect on merit scholarships. Schools award merit scholarships without regard to financial need.
Grandparents, aunts, uncles or other relatives and family friends can save for college without jeopardizing a child’s chances for financial aid as long as the money stays in their accounts. These can be 529 college savings plans or other investment accounts.
When grandparents eventually withdraw money from an investment account to use for their grandchild, parents must report this money as the child’s untaxed income on the Free Application for Federal Student Aid (FAFSA) and the CSS/Financial Aid PROFILE (if applicable).
In addition, these gifts must be reported on the child’s income tax return. This income can reduce aid eligibility by as much as half of the cash withdrawn from the college savings account.
Let’s say a grandmother contributed $10,000 to help defray her granddaughter’s tuition cost. When completing the FAFSA, the granddaughter’s parents would have to declare this gift. As a result, her grandmother’s contribution would be treated as the child’s income and be assessed at 50% in the FAFSA formula for determining Expected Family Contribution (EFC).
$10,000 X 50% = $5,000
Based on the formula, the child’s financial aid eligibility would drop by $5,000. Put another way, EFC would rise by $5,000.
The FAFSA does provide a way to help blunt or eliminate the penalty triggered by a grandparent’s largesse. The FAFSA gives each student an automatic income allowance that is adjusted annually. For the 2017-2018 school year, the allowance is $6,420. A student can earn $6,420 without having his or her income subject to the 50% assessment.
Consequently, in this example, the student’s income allowance would help offset the impact of the grandparent’s $10,000 gift to help pay her college costs.
A grandparent with a 529 plan can transfer the ownership to a one of the grandchild’s parents. Once the transfer is made, the money is treated as a parental asset that is assessed at no more than 5.64% in the FAFSA EFC calculations.
$10,000 x 5.64% = $564
Using the same example, a transfer of $10,000 from the grandmother to her granddaughter’s parents would only increase the EFC by $564.
Arguably the best strategy for grandparents is to wait until the parents have filed their child’s second-to-last FAFSA and PROFILE. This filing can happen as soon as the first semester of the child’s sophomore year in college. Using two-year-old tax returns, parents can file as early as October 1 for the following school year.
After that application is filed, money that grandparents chip in for college won’t have any effect on financial aid awards.