So Grandma wants to help pay for college? Fantastic! Tapping into extended family resources can certainly help parents overwhelmed by college costs. And since tuition payments are exempt from the gift tax, a grandparent’s help seems to be an effective way to disseminate family wealth without negative tax implications.
Unfortunately, many families don’t realize that there can be negative financial aid implications when a grandparent helps out. Unless Grandma is simply looking to for a way to exhaust her unlimited financial resources—if this is the case, I will happily accept college payments for my two kids!—families presumably want to maximize Federal, state, and institutional financial aid programs before turning to Grandma for assistance. Unfortunately, failure to plan properly for Grandma’s college contribution can lead to thousands of dollars in lost financial aid and a larger financial burden being born by both parents and grandparents.
The Problem: Gifts as Student Income
The FAFSA, a financial aid application required by just about every college in the US, asks students to report “money received, or paid on [their] behalf” by anyone other than their custodial parents. This is where students are required to disclose cash gifts given, or tuition bills paid, by Grandma (out of her 529 College Savings Plan or otherwise). These gifts from Grandma count as untaxed student income, and student income, after a small allowance to cover earnings from a part-time summer or after school job, is actually subject to the harshest assessment rate imbedded in the federal financial aid formula—a whopping 50%. In other words, a student potentially loses 50 cents of financial aid for every dollar that Grandma pays towards his tuition.
The Solution: Time Gifts Strategically
While the harsh treatment of relatives’ tuition payments as student income poses a significant financial problem for many families, it is not an unsolvable one, at least at the vast majority of colleges that use the FAFSA as their sole financial aid application. A little upfront planning can go a long way in minimizing—if not totally eliminating—the negative financial aid impact of Grandma’s college payments.
- First, remember that students are currently given a $6,400 income protection allowance, permitting them to work a small part-time job without costing themselves financial aid. Keep total student income, including gifts from Grandma, under $6,400 per year, and there will be no associated loss of financial aid.
- Also, beginning with the 2016/17 academic year, the FAFSA form will ask about a student and parents’prior-prior year income (e.g. income from two years back). That means that any gifts that a student receives will show up on a financial aid application two years in the future. Following along an approximate timeline (slightly inaccurate due to differences in calendar years and academic years), consider this: any payments Grandma makes for a student’s freshman year will cost him financial aid in his junior year, payments made toward sophomore year will cost him senior year aid, and any payments made for junior and senior years of college will not cost him any financial aid because there will be no more subsequent aid applications. Grandma can pay as much as she wants towards her grandchild’s last two years of college (actually beginning January of sophomore year), and there will be absolutely no financial aid impact.
- And if Grandma is so generous that giving $6,000 each toward freshman and sophomore years, and unlimited contributions toward junior and senior years, is not enough for her (again, she’s welcome to adopt me…), then she can always contribute to a 529 College Savings Plan owned by the parents of her grandchild. That account will feed into the financial aid calculations, but will be subject to the fairly gentle treatment of a parental asset, and suffer, at worst, a 6% annual assessment. Much less than the 50% assessment on student income!
While we all might not have a wealthy grandmother willing and able to pay for all four years of college, parents overwhelmed with the prospect of paying for college often overlook the potential generosity of their extended family. Asking for gift contributions to college funds to honor holidays and birthdays is a smart strategy for building up college savings, and when the time comes to spend that savings, parents should be sure to think strategically about any financial aid and tax implications of their spending in order to minimize their bottom line college costs—their own, their child’s, and Grandma’s.