Borrowing for College: Advice about Loans for Students and ParentsSuzanne Shaffer
If your child has grandparents who want to help foot the bill for college, first, consider yourself lucky. Next, make a plan so their generosity doesn’t end up actually driving up your costs.
That’s right. Without proper planning, a gift from grandma can cut into your child’s eligibility for financial aid and cost you in the long run.
As tuition continues to increase at twice the rate of inflation, paying for college is the second largest expense most families will face in their lifetimes. The average annual cost of an in-state public college now stands at $24,610, according to CollegeData.com. For private colleges, the price tag nearly doubles, costing $49,320 annually. No wonder outstanding student loan debt is now approaching $1.4 trillion.
Grandparents often step in to help out with those rising college costs. According to a survey by Fidelity Investments, more than half of American grandparents are either helping to fund their grandchildren’s tuition or plan to do so in the future.
To see why discussing a potential gift from grandparents in advance is so important, just look at what an impact a one-time gift can have.
Under IRS rules, a grandparent can give your child up to $15,000 a year without paying a gift tax. But the IRS isn’t the only player in this game. Where that gift will have a negative impact is when it comes to filling out the FAFSA (Free Application for Federal Student Aid). That’s because the FAFSA will count that $14,000 gift as untaxed income, which may reduce the student’s aid eligibility. What if the grandparent bypasses the child and makes a payment directly to the school? That payment could still have a negative impact on the student’s eligibility for aid.
All of this is a moot point if your child doesn’t qualify for need-based aid, but you won’t know that until you fill out a FAFSA and have schools calculate your EFC (Expected Family Contribution). This figure is determined by family income and who in the family earns the income, as well as assets, who owns those assets and in which accounts those assets are held. If your family has more than one student in college in any given year, this also factors in.
Options grandparents might choose include a 529 savings plan, a Uniform Gift to Minors Act (UGMA), a Uniform Transfers to Minors Act (UTMA) or a Coverdell Education Savings Account (ESA). All plans offer their unique set of pros and cons.
This option offers several advantages: a grandparent-owned 529 isn’t factored in on the FAFSA, earnings are tax-free, withdrawals aren’t taxed if the funds are used for qualified educational costs and 33 states offer tax breaks on contributions. Plus, 529 plans are not restricted to the state you live in. Grandparents can shop around among different states to find the plan that offers the best options.
What’s the downside to grandparents using a 529 to help pay your child’s tuition? It’s a big one. Once funds are withdrawn to pay for tuition, the distribution is considered income on the student’s FAFSA for the next two years. That could reduce the amount of aid they receive in those years. But there is a workaround: some experts suggest holding off on making contributions from a 529 plan until students are college juniors and have filed their last FAFSA.
These accounts usually offer more investment options than 529 plans but they involve turning over control of the account to the student when they reach a specific age. In addition, they are considered a student asset on the FAFSA and so are assessed at a much higher rate on the FAFSA than assets held by parents.
The key is making sure grandparents understand not just the options they have for saving money for your child’s education, but also how to make the most of their gifts. Sit down as a family to make a plan. If you’re attending a talk at your child’s school or in your community about paying for college and the grandparents live nearby, invite them along. And if you’re confused about the process, seek out an adviser experienced with college financial planning to help your family come up with a strategy.
With a little bit of planning, you can avoid having any penalties assessed on the grandparents’ generosity and just enjoy the gift.
Jim Slowik is a college financial expert at MyCollegePlanningTeam.com, a Naperville, Illinois based organization that brings together experts from both the academic and financial services communities who work in coordination to help families find the right college for the right price. Contact him at 630-871-3300 or Jim.S@mycollegeplanningteam.com.