How can grandparents best help with college costs?
It’s an important question because well-meaning grandparents can inadvertently sabotage a family’s chances for financial aid.
A popular way for grandparents to save for college is through 529 college savings accounts. These tax-advantaged accounts are available in every state and offer a lineup of underlying mutual funds.
The good news is that grandparents can save large amounts of money in 529 plans without hurting a grandchild’s chances of financial aid. The most common financial aid form, the Free Application for Federal Student Aid, does not ask about third parties saving for a student’s college education. So as long as the money remains undisturbed in a 529 plan, there is no chance that it will jeopardize aid.
The Bad News
The rules change, however, once a grandparent withdraws money from a 529 plan to pay college expenses. Then the federal government and colleges get very interested in this cash.
Let’s suppose that a grandmother withdrew $25,000 from a 529 account in 2012 to help her grandson. When the student’s parents complete the FAFSA for the 2013-2014 school year, they will have to divulge that outside 529 withdrawal.
Unfortunately, the financial aid formula treats the grandparent’s withdrawal as the student’s income. This income is assessed at 50%.
According to the formula, the student’s eligibility for need-based financial aid would drop by up to $12,500.
Luckily, there is an excellent way to disarm this potential financial aid time bomb. Here’s how:
The grandparent could postpone withdrawals until the child’s parents have filed their last financial aid form. This will typically occur in the late winter or spring of the student’s junior year in college. After the family has completed their last FAFSA for the student’s final year in college, the finances of the child and parents will be irrelevant.
Not all grandparents, by the way, will need to follow this advice.
If the student’s parents do not qualify for need-based financial aid, grandparents can use their 529 cash at any time.