Options include cash gifts and funding a 529, but beware the financial aid impact.
Question: I want to help my grandchildren pay for college, but I don't want to affect financial aid eligibility. What's the best way to help?
Answer: Helping pay for a grandchild's college education is an admirable goal, especially given the financial strain college can put on families. But before your clients start writing checks to help out their grandkids, make sure they have taken care of their own financial needs. If there's any question about whether they've saved enough for their own retirement, they're better off letting the grandkids and their parents fund college on their own. After all, they'll have plenty of opportunities to borrow money for college if they need to, but no financial institution will loan your clients money for their retirement.
Once they've determined they're financially secure enough to help, it's time to think about what strategy best suits not only their situation but also that of their kids and grandkids. There are several different ways grandparents, aunts, uncles, friends--pretty much anyone--can help students with college costs, but don't decide on any one path until you've considered all the implications.
The Complications of a Cash Gift
The easiest, most straightforward way for a nonparent to help a student pay for college is with a cash gift to the student or to his or her parents. Gift tax rules allow any individual to give another individual up to $13,000 per year ($26,000 from a couple) without the gift counting against the lifetime estate tax exemption. But there's a problem with this approach--aside from the fact that there's no guarantee the recipient will use the money for the purpose you intend--and it comes into play for students applying for need-based financial aid.
On the Free Application for Federal Student Aid, or FAFSA, the most widely used financial aid application, cash given directly to a student the year before he or she applies may be considered student income, reducing need-based aid by as much as 50% of the amount given. (For dependent students, the first $6,130 in income received does not affect aid, but anything beyond that is subject to the 50% reduction.) To make matters worse, money held in the student's name is treated as a student asset, reducing aid by another 20%. So that gift of $13,000 could end up costing the student up to $9,100 in financial aid. Cash given to the parents counts as a parental asset, though not as parental income, and also counts against financial aid, but at a much lower rate of up to 5.64%. That means a $13,000 gift made to the parents would potentially cost the student just $733 in financial aid. Much better, but still not ideal.
To avoid any financial aid impact with a cash gift, keep in mind that the FAFSA takes into account income from the prior year in determining need-based aid. So cash given to a student the year before he or she enters college--as a high school graduation present, for example--could reduce the amount of need-based aid the student receives the following year. To avoid this, your clients may consider giving the money when they know the student will not be applying for aid the next year. That could mean giving money before Jan. 1 of the student's junior year of high school or after Jan. 1 of the student's final year of college. (If the latter, be sure the student will not be applying for aid for further studies the following year.)
Lending a Hand With Loans
Another approach that is even cleaner is for grandparents to offer to help pay back the student's loans. By waiting until the student is done with school, they avoid financial aid concerns and help ease the student's debt burden as the student enters the workforce. Mark Kantrowitz, publisher of financial aid website FinAid.org, says that for many grandparents, this option makes the most sense.
"When deciding how to contribute to a grandchild's college education, grandparents should consider the impact of their contributions on the student's eligibility for need-based financial aid, the impact on gift taxes, and the impact on estate planning. Often the best option is to wait until after the student graduates and then help the student pay off his or her student loans as a graduation present," Kantrowitz said.