Why Your Grandparents Could be Your Meal Ticket to College
By The Fastweb Team
August 17, 2017
There are many ways in which grandparents can help their grandchildren pay for a college education. These include legacy scholarships and tuition assistance programs, educational awards for volunteering and community service, college savings plans and direct gifts.
Scholarships for Grandchildren
Very few scholarships are based on a grandparent’s affiliations. There are many more awards based on a parent’s affiliations. However, sometimes awards that are available to a parent’s dependents may also be available to grandchildren. Grandparents may have more relevant affiliations than the grandchild’s parents. (On the other hand, there are also a few awards, like the Rotarian scholarships, which are not available to students who have a close relative, including a grandparent, who is a Rotarian.)
You can help your grandchildren find scholarships based on your affiliations by giving them a resume that summarizes all of your affiliations, including past and present employers, unions, military service, memberships, hobbies and activities, in addition to details concerning religion, race and ethnicity. Not only will you be helping your grandchildren find scholarships that match their background, but you will be giving them an opportunity to learn more about you and your family history.
Grandparents can also spend time with their grandchildren to help them study and get good grades or participate in volunteer activities together. This can help them qualify for more awards.
The best way to find scholarships for grandchildren is to use Fastweb’s free scholarship matching service. When completing the profile on FastWeb or any other scholarship database, your grandchildren should carefully review the questions that ask about a parent’s employers and affiliations, as some of these also apply to grandparents. Students who answer all the optional questions will typically get twice as many matches as students who answer only the required questions.
The three main types of scholarships that may depend on a grandparent’s affiliations include legacy scholarships for grandchildren of a college’s alumni, scholarships for military service by a grandparent, and scholarships based on ancestry and ethnicity.
1. Legacy Scholarships.
Several colleges provide assistance to “legacies”, which are descendants of alumni. While this is most often expressed through admissions preferences, there are a few that have scholarship funds for grandchildren of alumni. Many colleges have what are known as Legacy Scholarships for students whose grandparents previously attended the college. Students should check the admissions and financial aid websites of the schools they’re interested in as well as ask the college during the admissions process.
2. Scholarships for military service by a grandparent.
Most scholarships for military service are restricted to dependents of a parent who served, but there are a few awards for military service by a grandparent. Examples include the Marine Corps Scholarship Foundation that provides awards for students with grandparents that served in certain divisions. The American Legion is a good source of information on this topic.
3. Scholarships based on Ancestry and Ethnicity.
While not specifically restricted to grandchildren, there are a variety of scholarships based on a student’s ancestry and heritage. One example is the Order of Sons of Italy in America, which requires at least one Italian or Italian American grandparent. The US Bureau of Indian Affairs also awards aid based on having at least 1/4 native american blood (i.e., at least one grandparent is full-blooded).
Educational Awards for Volunteering and Community Service
Various volunteer organizations provide scholarships for children and grandchildren of members. Examples include the Idaho School Board Association, Connecticut Association of Purchasing Management (parent or grandparent must be a CAPM member), and the Elks National Foundation.
The Edward M. Kennedy Serve America Act (HR 1388) authorizes the Senior Scholarships program. This program provides $1,000 education awards for people age 55 or older who volunteer for 350 or more hours a year. These awards may be used for the volunteer’s own education or transferred to a child, foster child or grandchild. Congress must still vote to appropriate funding for the program as part of the President’s FY2010 budget.
Contributing to College Savings Plans
Approximately a quarter to a third of grandparents help their grandchildren save for college through 529 college savings plans, gifts or other means.
529 college savings plans, prepaid tuition plans, Coverdell education savings accounts and Series I and certain Series EE savings bonds are tax-advantaged ways of saving for college. Distributions are tax-free when used to pay for qualified higher education expenses and are not counted as income or resources when evaluating eligibility for federal need-based student aid. Many states allow you to detect all or part of your contribution to the state 529 college savings plan on your state income tax return. You can contribute up to the annual gift tax exclusion ($13,000 in 2009 per grandparent per beneficiary) without incurring any gift taxes. 529 college savings plans also allow for larger lump sum contributions using 5-year gift tax averaging.
When a grandparent owns a college savings plan, it is sometimes disregarded when calculating a student’s eligibility for need-based aid. However, this does not necessarily increase the amount of student aid the grandchild will get as compared with parent or child ownership of the college savings plan. For example, section 529 college savings plans, prepaid tuition plans and Coverdell education savings accounts are not reported as assets on the Free Application for Federal Student Aid (FAFSA) of a dependent student if they are owned by a grandparent of the student. This is due to a change enacted by the College Cost Reduction and Access Act of 2007. The change was effective starting in 2009-10.
The specific legislative language was:
(3) A qualified education benefit shall be considered an asset of -- (A) the student if the student is an independent student; or (B) the parent if the student is a dependent student, regardless of whether the owner of the account is the student or the parent.
As such, college savings plans owned by a grandparent are not reported as an asset when calculating the need-based aid eligibility of a dependent grandchild. This is in contrast with student assets, which are assessed at a rate of 20%, and parent assets, which are assessed at a maximum rate of 5.64%. (While student assets are normally assessed at a 20% rate, custodial 529 college savings plans owned by a dependent student are treated as though they were parent assets and so are assessed at a maximum rate of 5.64%. Most parent assets, however, are not assessed at all, with only 4% of dependent children having any contribution from parent assets. Certain parent assets are sheltered from need analysis, including retirement funds, net worth of the principal place of residence, small businesses owned and controled by the family, and an age-based asset protection allowance that is typically around $50,000 for parents of college-age children. In addition, if the parents have income of less than $50,000 and satisfy certain other criteria, assets might be disregarded entirely. )
However, qualified distributions from grandparent-owned 529 plans will be reported as untaxed income to the beneficiary on the next year’s FAFSA. (Non-qualified distributions are reported as income to the beneficiary on the federal income tax return and so are included in adjusted gross income, regardless of who owns the 529 plan.) This will have a severe impact on aid eligibility, much worse than if the 529 plan had been reported as a parent asset, since as much as half the distribution will reduce the student’s eligibility for need-based aid.
There are two ways to address the problem. One solution is to change the account owner from the grandparent to either the student or the student’s parents. The 529 plan will then be reported as an asset on the FAFSA but qualified distributions will be ignored. The other solution is to wait until the student’s senior year in college to take a distribution, since there will be no subsequent year’s aid eligibility to be affect, assuming the student doesn’t enroll in graduate or professional school.
This treatment of grandparent-owned college savings plans applies only to federal student aid. Approximately 250 colleges use the CSS Financial Aid PROFILE form for awarding their own aid. This form requires the reporting of all college savings plans that name the student as a beneficiary.
An additional benefit of a 529 college savings plan is the value of the plan is excluded from the grandparent’s estate. It becomes an asset of the beneficiary upon death of the account owner. The only exception is for five-year gift-tax averaging for lump sum contributions, which is included in the estate on a prorated basis if the grandparent dies during the five-year period.
Grandparents can also contribute directly to a 529 college savings plan owned by a grandchild’s parent. This will be treated as a parent asset on the FAFSA.
CollegeInvest, the Colorado state 529 college savings plan, has an annual Grandparents Scholarship promotion where they give away 10 $2,500 college savings plans to Colorado grandparents.
Gifts to the Parents and Students
If a grandparent gives a gift to a parent, it is not reported as income (taxed or untaxed) on the FAFSA. If the grandparent gives the money to the grandchild, however, it is treated as untaxed income and affects aid eligibility (by as much as 50%).
One workaround is to wait until after the grandchild graduates and then give a graduation present to help pay off the grandchild’s education loans. Since this gift occurs after college graduation, it will not affect the grandchild’s eligibility for need-based aid.
Giving Directly to the College
Many personal finance and tax experts recommend giving money directly to the college to avoid gift taxes. This is bad advice for most families because it hurts eligibility for need-based financial aid. It should only be considered if the family does not qualify for need-based financial aid and the annual gift tax exclusion is insufficient.
Section 2503(e) of the Internal Revenue Code provides a gift tax exclusion for money paid directly to an education institution to pay for tuition on behalf of a student. However, the exclusion is limited to amounts paid for tuition (not room and board or other expenses) and the payment does not count as a charitable contribution. The potential gift tax savings will also be much less than the negative impact on need-based aid, yielding no net benefit to the student. Moreover, with the annual gift tax exclusion at $13,000 ($26,000 joint) in 2009, it doesn’t seem like it is really necessary to make the payment directly to the college.
Direct payments to the college will be treated unfavorably by federal need analysis. It cannot be treated as just a payment on the student’s account because eligibility for the gift tax exclusion is dependent on the amount being paid for tuition. There are two possible approaches based on the statute and regulations. One approach treats the payment as untaxed income to the child (i.e., cash support within the scope of section 480(b) of the Higher Education Act of 1965). This reduces need-based aid by 50% of the amount of the direct payment. Another approach treats the payment as a resource (i.e., estimated financial assistance within the scope of the regulations at 34 CFR 673.5©(1)(xiii)). This reduces need-based aid by 100% of the amount of the direct payment, dollar for dollar.
Grandparents are not eligible to borrow from the Federal Parent PLUS loan program unless they have formally adopted the grandchild. A legal guardianship is not sufficient.
Grandparents can, however, cosign private student loans on behalf of their grandchildren. Yet they should be cautious about cosigning on any loans, as this makes them just as responsible for repaying the loan as the student borrower. The lenders use fairly minimal credit underwriting standards for cosigners, such as a minimal threshold on annual income. They do not currently use debt-to-income ratios. This means that a grandparent on fixed income might end up obligated on private student loans for amounts that are far greater than what they can afford to repay. If the student defaults on the loan, or is even a month delinquent, the lender can seek repayment from the cosigner. This may put the grandparents in a difficult financial situation.
Grandparents who own a Roth IRA can name their grandchildren as primary beneficiaries. While the Roth IRA will be included in the grandparent’s taxable estate and so be subject to federal estate tax, in many cases the Roth IRA will pass to the grandchildren tax free if the total estate is less than the unused portion of the unified credit. The grandchildren can then avoid the 10% early distribution penalty and withdraw earnings tax-free even if they are under age 59-1/2. (For all distributions to be tax-free, a Roth IRA must have existed for at least five years before the distribution. Otherwise the earnings the accumulate after the contribution to the Roth IRA will be taxable.) Usually the grandchild must take a distribution of the entire amount by the end of the fifth year following the previous owner’s death. But until the grandchild takes a distribution, the Roth IRA is disregarded as an asset on the FAFSA. Distributions will count as untaxed income on the FAFSA, affecting the subsequent year’s federal student aid eligibility.
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