Paying for college is an expensive prospect for parents and having grandparents chip in may be a welcome source of financial help. If students also plan to apply for financial aid, it's important to consider how grandparents' 529 plan contributions or cash contributions could affect their eligibility. Qualifying for federal aid, including student loans and grants, could be complicated by financial gifts from grandparents, depending on how those gifts are received.
How Can a Grandparent’s Gift Hurt Financial Aid?
Some grandparents hope to pay a child’s tuition expenses directly to the school or give a cash gift directly to students. While generous, the payments can complicate things when it comes to financial aid, as cash gifts count as untaxed income on the the Department of Education’s Free Application for Federal Student Aid (FAFSA).
The FAFSA determines a student's eligibility to receive federal financial aid. This form is completed for each year of school enrollment, and qualifies students for federal loans, grants, and scholarships.
The FAFSA establishes an Expected Family Contribution (EFC), based on reported family income from the previous tax year, current assets, and any benefits such as Social Security.
Beginning with the 2023-24 financial aid award year, the EFC will be replaced with a new formula, the Student Aid Index (SAI), to determine awards. Starting in October 2022, FAFSA applications will be simplified to incorporate the change.
Currently, assets include parent and child checking and savings accounts, investment properties, and the value of stocks and bonds. In general, the formula used is: Cost of school attendance - EFC = financial need.
Only parental and student income and assets are considered in the EFC. Even if a student lives with grandparents, a grandparent’s income isn’t considered in calculations unless the child is legally adopted. This will not change under the SAI formula.
The EFC’s “assessment rate” calculates how much of your income and assets could be contributed to college costs. The EFC also considers parental age, state of residence, how many college students are in the home, and other taxes paid, among many factors.
Generally, more of a student’s income and assets are considered as eligible to contribute toward school costs. For example, a parent’s assets benefit from a “protection allowance” based on age; of remaining assets, 12% may be considered toward the EFC. All of a dependent student’s assets are considered at a 20% rate, without a protection allowance.
According to U.S. Code where student assistance is concerned, untaxed income is "any cash support or money paid on the student's behalf, except, for dependent students, funds provided by the student's parents."
Grandparent 529 Contributions and Financial Aid Eligibility
Grandparents can open a 529 college savings account to set aside college money for their grandchildren, providing the opportunity to make tax-deferred contributions and tax-free withdrawals for college. Some states even offer tax deductions for owner contributions. But 529s can have some surprising issues.
With 529 accounts, there is an owner and a beneficiary. The student/grandchild is typically the beneficiary. Until money is withdrawn, a 529 is a grandparent’s asset, and does not count against a student’s financial aid calculations.
But when grandparents withdraw money from a 529 plan to pay college expenses on behalf of a student, the money is treated as “untaxed income” for the student on the next year’s FAFSA, which can heavily impact aid eligibility the following year. To avoid this scenario, here are four options:
Transfer the 529 Ownership to a Parent
If your plan or state permits doing so, transfer ownership of the 529 to the student’s parent. A 529 savings account is reported as a parental asset on the FAFSA. However, some states even exclude a parent-owned 529 account when calculating need. However, there may be federal, state, and local tax consequences in some circumstances, so speak with a CPA first.
Contribute to a Parent-Established 529
A grandparent can contribute up to $15,000 per year ($30,000 for joint filers) without triggering IRS gift taxes to a 529 plan that parents established on behalf of their children. A parent-owned 529 counts as an asset of the parent, which is taxed at the lower parent asset rate.
Gift 529 Money Directly to a Parent
If a grandparent sends withdrawn 529 money to their child (the grandchild’s parent) for the grandchild’s higher-education expenses, that money will count as a parental asset, but likely be considered at the lower parental rate. Once again, it’s subject to the IRS gift tax restrictions.
For every $100 increase in available assets, a parent’s expected contribution only increases between $2.64 and $5.64.
Delay 529 Withdrawals
A grandparent can delay withdrawals from a grandchild’s 529 plans until the student's last year of undergraduate or graduate school. This won't affect aid for future years, since the student would be done with school anyway. This assumes they graduate on time, aren’t planning to attend graduate school the following year, and so no longer need to take future 529 plan withdrawals.
You don't have to be a resident of a particular state to enroll in that state's 529 college savings plan, although there may be tax consequences upon withdrawal.
How Else Can Grandparents Give Money to College Students?
In some cases, grandparents may be looking for a way to help with college costs and give themselves an advantage when it comes to estate planning.
Grandparents can put money in a Roth IRA, either in their own name or one that belongs to the student, for future retirement years. Just remember that gifts during the college years will count as untaxed income for FAFSA purposes.
As long as the money remains in the Roth, it generally won't impact financial aid eligibility, because retirement account assets are not considered as part of EFC. But some schools, such as Harvard University, do ask students to report Roth IRAs and other retirement accounts.
Money you've contributed and earnings can be withdrawn from a Roth IRA in certain circumstances, such as for qualified higher education expenses, without paying a penalty tax.
Some grandparents may want to stash gifts in a Uniform Gift to Minors Act (UGMA) account or a Uniform Transfer to Minors Act (UTMA) account instead. However, these are considered student assets by the Department of Education, and could hurt financial aid.
Finally, a grandparent could gift up to $15,000 to parents for a grandchild’s college expenses. The FAFSA will count the gift as a parental asset, which is more beneficial than being considered a student asset.
Federal financial aid eligibility takes income and assets for both parents and students into account. Grandparents' 529 gifts can shrink a student's financial aid eligibility more than parents' assets or income, but there are several ways to minimize the impact of a grandparent’s gift on financial aid eligibility.