How a Grandparent's Help With College Tuition Affects Financial Aid

Question: I read your column about how you can avoid the gift tax limits by paying a grandchild's tuition directly to the college. But wouldn't this affect the student's eligibility for financial aid?

Answer: Yes, paying your grandchild's tuition could have a big impact on financial aid in future years. That may not be an issue if you plan to pay your grandchild's tuition through the last few years of college. But it's important to keep in mind if you're only paying a portion of the cost or only helping out in the early years of college and your grandchild will be applying for aid to pay the rest.

Grandparents often pay tuition directly to a college because it helps move more money out of their estate without being subject to gift taxes. You usually need to file a gift tax return if you give more than $15,000 to any individual in 2018 (couples may give up to $30,000), but any money you pay directly to the college for your grandson's tuition isn't subject to those limits. However, money paid directly to the college must be reported as cash support on the student's federal financial aid forms and may reduce eligibility for need-based financial aid two years later, says Mark Kantrowitz, publisher of Savingforcollege.com.

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Cash support is counted as untaxed student income in the financial aid calculations, and students are expected to contribute up to 50 cents for every dollar of income toward college bills (after an income-protection allowance of about $6,750 a year). Kantrowitz says some colleges will treat the payments as a "resource" because they are restricted to tuition, in which case the payments can reduce a student's eligibility for need-based aid dollar for dollar.

Another option for helping a grandchild with college bills that will have less of an impact on financial aid is to contribute to a 529 college-savings plan owned by the parents, says Kantrowitz. You can contribute up to five years' worth of the annual gift tax limit to a 529 plan—currently a total of $75,000—in a single year. You won't, however, be able to give your grandchild any more money for five years. The 529 money can be used tax-free for tuition, required fees and books, and room and board.

Withdrawals from 529s that are owned by the parents are not reported as income on the Free Application for Federal Student Aid (FAFSA). The money is considered a parental asset, and the impact on financial aid is much smaller than if the withdrawals were taken from a grandparent-owned 529. If the grandparent owns the 529, the assets aren't included in the financial aid calculations, but withdrawals are counted as student income on the FAFSA. See How a Grandparent's 529 Account Affects College Financial Aid for more information.

For more information about the financial aid calculations, see New Strategies to Get More Financial Aid.