Helping to Pay for College
College is one of the largest investments most people will make in their lifetimes. Few make it through without financial help from family or other financial aid. This week’s column is geared toward parents, grandparents, and others who want to help a young college student pay for college. There are certain ways to help that are more helpful than others. Unless you are careful, your well-intended gesture could hurt your student’s eligibility for other financial aid. Here are some things you should know.
Every college student seeking financial aid must fill out a form called the Free Application for Federal Student Aid, or FAFSA. One purpose of FAFSA is to determine something called the Estimated Family Contribution or EFC—a measure of the student’s financial need. In addition, many colleges use the FAFSA to determine eligibility for their own financial aid. You can fill out the FAFSA online at www.studentaid.gov. There are also several online calculators that can help you understand how your student’s EFC will be affected by different factors. Simply google EFC calculator.
FAFSA has some idiosyncrasies. Here are four that you need to understand. First, FAFSA collects information about student and parent assets as of the date the FAFSA is filed. However, strange as it may sounds, the income information you report on FAFSA is from two years ago. If you were filling out a FAFSA for the 2020/2021 academic year, it would ask you for your income in 2018.
Second, FAFSA counts cash support to the student, including gifts and money paid on behalf of the student for housing, food, clothing, medical care, transportation, and college expenses as untaxed income. Cash gifts given to the parents, on the other hand, are not reported on the FAFSA.
Third, assets held by the student affect eligibility more than assets held by the parent. Student assets reduce eligibility by 20 percent of the asset value, while parent assets reduce eligibility on a sliding scale with the highest rate being 5.64 percent.
Finally, money that is held in a 529 plan owned by the student or the student’s parents is reported as a parent asset and distributions from the 529 plan are not included in income. On the other hand, 529 plans owned by grandparents or other family members are not counted as an asset on FAFSA, but the distributions are counted as income to the student.
Understanding these quirks can help you maximize your student’s eligibility for financial aid. For example, because FAFSA income is reported with a two-year lag, you may want to wait until on or after January 1 of the student’s sophomore year to give them a cash gift. If they graduate in four years, that gift will never show up on a subsequent FAFSA and will never reduce their eligibility for financial aid. If they need money during their freshman year, you could have them borrow that amount with a student loan and then prepay the loan during their sophomore year with your cash gift.
You should also try to time your cash gift so it can be spent before the FAFSA is filed. Remember, FAFSA requires the student to report assets as of the day the form is filed. If your gift is still sitting in the student’s bank account when the FAFSA is filed, it will be counted as an asset and reduce the student’s eligibility. However, if the gift is spent before the FAFSA is filed, it will not be reported and will have no negative impact on their financial aid.
You should also be careful with distributions from 529 plans. Remember, there is a big difference between parents and grandparents when it comes to 529 plans. Distributions from a parent’s 529 plan are not counted as student income, but distributions from a grandparent’s 529 plan are. Therefore, if a grandmother wants to give her grandson a distribution from her 529 plan, she should first roll that money from her 529 plan into a 529 plan owned by one of the parents. Rolling it after the FAFSA is filed means it won’t be counted as a parent asset. It can then be distributed to the grandson without being reported as student income.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to firstname.lastname@example.org.