Helping grandchild without jeopardizing aid

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Q. My husband and I would like to help our grandson save for college, which will be in four years. What is the best way to save for him so that it doesn’t prevent him from getting scholarships and grants?
— Granny

A. There’s a lot to think about when it comes to college funding. It’s fantastic that you want to help, and it’s also wise that you want to give in a smart way.

Most financial aid is based on need.

College-bound students determine their eligibility for federal financial aid by filling out the Free Application for Federal Student Aid (FAFSA), said Gene McGovern of McGovern Financial Advisors in Westfield.

The FAFSA lists the student’s and parents’ income and assets.

“Information from the FAFSA is used to determine what’s known as the Expected Family Contribution (EFC), which is the amount the student and his or her family are expected to contribute toward that year’s cost of attendance at college,” McGovern said.

If the cost of attendance at college exceeds the EFC, federal student aid may be available to make up the difference. That aid includes various grants, loans, and work-study opportunities, McGovern said.

Some colleges also make scholarship awards from their own funds, based on the CSS/Financial Aid PROFILE, which considers more types of assets than the FAFSA.

While much of financial aid depends on income, schools also factor parent and student assets into financial aid decisions.

And the key factor about assets is who owns them, McGovern said.

“For parent assets, the maximum that’s expected to be contributed in any year is 5.64 percent,” he said. “For assets owned by students, however, colleges expect a 20 percent contribution.”

Assets owned by grandparents and other third parties are not counted in financial aid decisions, he said.

On the income side, 50 percent of student income goes into the EFC, McGovern said.

“Giving money to your grandson, then, results in the gifts being treated as untaxed student income, effectively reducing his eligibility for financial aid by 50 cents on the dollar,” McGovern said. “That’s true whether you give the money to your grandson or pay his tuition bill directly to the school.”

Similarly, distributions from a 529 plan owned by a grandparent for a student’s benefit are counted as income to the student, with a similar reduction in aid, he said.

Navigating the detailed rules that govern college financial aid awards can be tricky, but there are strategies that can help.

First, take advantage of timing rules.

McGovern said under a recent change in the FAFSA rules, when making financial aid decisions for an academic year (for example, September 2017 to June 2018), colleges now look at income and tax returns from two years ago (in this example, the 2015 tax return), rather than last year’s (2016) return.

“Therefore, if you wait to give money to your grandson until January of his sophomore year or later, the income won’t be listed or considered in any FAFSA, assuming he graduates in four years and isn’t going directly to graduate school,” McGovern said.

Alternatively, you might also consider waiting until your grandson completes college and then help to pay off any student loans. This might be offered as an incentive to graduate, or to graduate within four years, he said.

Another option is to give the money to the parents instead of your grandson.

Only up to 5.64 percent of parent assets are considered for financial aid versus 20 percent of student assets.

“If you think of these as marginal tax rates, it’s clearly better to give the money to the parents, provided you don’t mind giving up control over the funds,” he said.

If the parents have a 529 plan, you can often contribute directly to their plan rather than setting up your own. That way, your grandson won’t be considered to have income when the money’s taken out and used for education expenses, McGovern said.

Also keep in mind the gift tax rules.

Under current rules, you and your husband can each give up to $14,000 per year to anyone, gift-tax free. That means you can give up to $28,000 per year as a couple to your grandson.

Finally, if you pay your grandson’s college tuition directly to the school, there’s no gift tax at all.

“And if you wait until January of his sophomore year to start making those payments, there’s no impact on undergraduate financial aid, either, provided he graduates on time,” he said.

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NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.