You thought you were doing the right thing. You opened up a savings account in your child’s name when she was a baby. You’ve been diligently socking money away for years. Birthdays, holidays, bonuses… You’ve stashed all of that money in your daughter’s account in anticipation of college tuition bills, which will be here before you know it. While paying for college won’t be easy, with that savings account and some financial aid, you just might be able to swing it. You give yourself a pat on the back. Then comes the bad news from the college aid office. You don’t qualify for any financial aid. “How could that be?” you ask. While you’re not poor, your income is moderate and you certainly can’t afford to pay for college out-of-pocket. You must qualify for some assistance. Unfortunately, you’re informed, the balance in your daughter’s savings account put you out-of-range for any need-based aid. “It’s too bad,” the aid officer lets slip. “If only the money were in your account instead of your daughter’s, you would have had some eligibility.”
This parent (and many like him) learned the intricacies of the federal financial aid formula a little too late. The formula treats assets held in the student’s name much more harshly than assets held by parents, asking parents to contribute between 0 to 6% of their savings to college each year while asking students to contribute a full 20% of their savings annually. While these assessment rates are based upon the somewhat reasonable assumption that parents generally have greater outside financial responsibilities than students, the logic imbedded in the financial aid formula does not belay the fact that the name listed on your family’s college savings account can wildly swing the financial aid calculations for or against you.
If you’re lucky enough to learn of this idiosyncrasy prior to submitting college applications, the first inclination is to immediately transfer any money in their child’s account to their own in order to circumvent any negative financial aid implications. Unfortunately, these parents are on shaky legal ground, as this change of ownership, in the eyes of the courts, is tantamount to stealing their child’s money.
Parents who have saved for college in their child’s name and now realize they have made a potentially costly mistake do have two valid options that may solve their financial aid dilemma without landing themselves on the wrong side of the law:
- First, as custodians of their minor child’s savings account, parents can legitimately spend down the child’s money on any expense which directly benefits that child. Parents, do you have expenses for your child, such as summer camp, hockey equipment, drum lessons, class trips, private high school tuition, or college application fees, on which you were going to spend your own money? All of these expenses can be legally paid out of your child’s account in order to minimize his assets. Meanwhile, you can save the equivalent amount of money in an account in your name. This spend-down tactic allows you to legitimately shift ownership of assets while remaining on solid legal footing.
- Parents can also move the child’s savings into a Custodial 529 College Savings Account. While most 529s list a parent as the owner (or participant) of the account and the student as the beneficiary, a Custodial 529 lists the student as both owner and beneficiary of the account. Converting student savings to a Custodial 529 involves no change in the money’s legal ownership, but the federal financial aid formula conveniently considers all 529s in the household, even these student-owned Custodial 529s, to be parental assets for means of determining aid eligibility. This formulaic quirk provides Custodial 529s with a lower assessment rate than other student savings at most colleges. Parents should be cognizant of any potential inflation of student income when liquidating and reallocating student assets and the forfeiture of flexibility when utilizing a 529, but despite its limitations, the Custodial 529 can be an important strategic tool for parents realizing the implications of saving for college in their child’s name.
Parenthood is a tough job—one in which there is ample opportunity for slip-ups along the way. And while saving for college is never a mistake in and of itself, where a parent chooses to collect savings can be problematic when it comes to financial aid. The problem of student savings can be easily addressed, by parents who understand the financial aid formula and are proactive in responding to its peculiarities. Doing so can maximize financial aid eligibility while preserving family assets, an outcome for which parents deserve an extra pat on the back.