There are plenty of generous grandparents out there who would love to help their grandchildren with their college costs. While that's a wonderful instinct, the last thing that parents want is for grandma and grandpa's generosity to wreck a child's chances for financial aid. But there are ways around this. Below, I share seven tips that will allow grandparents to safely contribute to their grandkids' college education.
No. 1: First, determine whether you'll qualify for financial aid
If a family isn't going to qualify for any need-based financial aid, it won't matter how grandparents help out. These grandparents can save through a college account like a 529 savings plan, load up on savings bonds, make tuition payments directly to the school or help in some other way. It makes no difference what the grandparents do since the grandchild won't be getting need-based assistance from a college.
No 2: Delaying grandparent help
If a family hopes to qualify for financial aid, grandparents should consider delaying any contributions towards defraying their grandchild's college costs until at least the end of the student's junior year in college.
Why wait until then? Because the family will have completed the final financial aid application for their child's last year in college. So after that point, the college will no longer be asking about any windfall that a student receives from his or her grandparents.
If a child ends up taking more than four years to graduate — and many do — grandparents should postpone their contribution until the last aid application is filed regardless of when that is.
To be even safer, grandparents might want to wait until the child is nearing his or her college graduation. That's because the federal government audits a certain number of financial aid applications every year and parents don't want to have to explain why the assets may be considerably more than when the aid application was filed.
No. 3: Be careful with 529 plans
Here is the good news for grandparents who save through 529 college accounts: parents don't have to divulge any grandparent 529 accounts when they complete the Free Application for Federal Student Aid or FAFSA. The FAFSA is the yearly form that parents must fill out to be eligible for financial aid.
While this sounds great, there is a troubling catch. When grandparents tap into a 529 plan to help pay for college expenses, the parents of the student must report this cash as untaxed income on their FAFSA. This income can shrink aid eligibility by as much as half of the money pulled out of the 529 account. Ouch!
No. 4: Avoid a 529 plan disaster
Again, you can avoid the potential 529 withdrawal fiasco if you ask the grandparents to wait to tap into this college account until after the student's last financial aid form has been filed. Another solution is to have the grandparents transfer the money from their 529 plan into a 529 account that the parents own. For financial aid purposes, the money in a 529 plan controlled by the student's parents is assessed at the far more favorable rate of 5.64 percent.
No. 5: Understand the PROFILE exception
You just read that the FAFSA doesn't care if a grandparent is squirreling money away in a 529 plan as long as that money isn't actually tapped for college.
However, a less common financial aid application, the CSS/Financial Aid PROFILE, does care about the existence of grandparent 529 plans.
The PROFILE will ask about the existence of any college accounts that name the student as a beneficiary. This won't be an issue for the vast majority of families since only 270 mostly private colleges and universities use the PROFILE. You can find the list of these colleges by Googling “PROFILE.”
No. 6: Beware of Custodial Accounts
What if grandparents have stashed funds in an UGMA or UTMA account in the child's name? This isn't a wise thing to do because the money is considered an asset of the child. And this is true regardless of whether parents or grandparents have established the custodial account.
The money in a custodial account will reduce a child's financial aid eligibility by 20 percent of the total. Parents are expected to report the existence of any custodial account for the student on the FAFSA, and that's true even if a grandparent established it.
To defuse this time bomb, a grandparent can transfer the money in a UGMA or UTMA into a custodial 529 account. Once that's done, the money will be treated as a parent asset and, as such, the cash will be assessed at a maximum of 5.64 percent.
No. 7: Avoid making direct payments to a college
Grandparents also should not make direct tuition payments to a college. That's because a college can reduce its financial aid to the child — dollar for dollar.
Helping a grandchild with college costs can be a tremendous gift, but just be sure your clients do it right.
Lynn O'Shaughnessy is a college consultant, author and speaker. She writes three college blogs for CBSMoneyWatch, U.S. News & World Report and TheCollegeSolutionBlog.com.