Grandparents: Doing More Harm Than Good

It’s great when grandparents can help with college costs, but you don’t want their generosity to backfire.

At a 4th of July party this weekend, I talked with a couple whose children’s college choices have, strangely enough, been diminished by grandparents money.

Here’s what happened:  Years ago the grandparents gave each of the three children a significant amount of money that they intended for them to eventually use to help buy a house in San Diego, one of the nation’s more expensive real estate markets.

The dad and mom are middle class, but the money in the children’s names has just about eliminated their chances of getting financial aid from private colleges. The family makes too much money to qualify for financial aid at state universities in California. To qualify for aid at state schools in California, a family of four would typically have to make less than $80,000.

The children would have seen a big chunk of their windfall disappear if they used it to pay for private colleges. Or they could keep it and attend a state school. That’s what one son, who attends UCLA, ended up doing.

If the grandparents had kept the money until the children graduated from college, their school choices would have expanded greatly.

Five Tips When Grandparents Want to Help Out

Here are some previous suggestions that I made about grandparents’ roles in helping with college costs:

No. 1.

If your family isn’t going to qualify for need-based financial aid, it doesn’t matter how grandparents save for college or how they help pay the tab. It can, however, be an issue for families who are worried that a grandparent’s generosity could shrink their financial aid package.

No. 2.

If financial aid is an issue, grandparents should ideally wait to kick in money until after the family has filed for financial aid in the spring of a child’s junior year in college.

Why then? Because this represents the last financial aid application the family will submit. After that form is completed, a college will no longer ask about a family’s finances. To play it safe, it would probably be better to wait until the child’s senior year or until graduation.

No. 3.

What about grandparents saving through 529 college plans? This money is not counted as an asset when parents fill out the Free Application for Federal Student Aid or FAFSA. Families must fill out this form if they want to qualify for need-based aid.

There is, however, a catch. When grandma withdraws money from the 529 plan to use for her grandchild, parents must report this money as untaxed income on the FAFSA. This income can reduce aid eligibility by as much as half of the cash withdrawn from the college account. Not good!

No. 4.

To avoid the above 529 disaster, tell grandma to wait and withdraw the money after the parents have filed that last financial aid form in the spring of the child’s junior year of college.

Or grandma could sink the money into a 529 plan that the grandchild’s parents own. For financial aid purposes, this money is accessed much more favorably at a maximum parental rate of 5.64%.

No. 5

Beware: If your child is interested in private colleges that use the CSS/Financial Aid PROFILE, these institutions do ask about the existence of any college accounts that name the student as a beneficiary. Here is the list of schools that use the PROFILE.

Lynn O’Shaughnessy is the author of The College Solution and she also writes a college blog for CBSMoneyWatch and another for US News & World Report. Follow her on Twitter.

 

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One Response to Grandparents: Doing More Harm Than Good

  1. brett July 8, 2011 at 3:29 pm #

    Question for you, Lynn, as this is an interesting article.

    My grandmother currently gives my son I think $11,000 a year, as that is the most she is allowed to give by law without being taxed. The reason for this is to avoid estate tax which will ultimately be charged when my grandmother passes (hopefully not for a long time!)

    Estate tax is about 1/3rd — varies by level. So if I were to get $11k now, I get $11k. If I get 11k as an inheritance, I only get $7300 — I have lost $3700.

    Thus, it is better to get the money NOW and get less aid. Afterall, aid needs to be paid back in full anyhow, so I’m not really “getting” money – just a loan. The $3700 is REAL money, and it’s more important to take that.

    Am I reading this right? Let me know your thoughts, as your response could change our planning. Email me back!

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