Tips for Grandparents on Helping Grandchildren Pay for College
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.)
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. For example, the "Grandma Scholarship" at Hood College lets incoming freshmen pay the same first-year tuition rate as their alumnus grandparent. Other scholarships for grandchildren include the alumni heritage scholarship and the alumni scholar award at the University of Alabama, Augustus Ward Young and Ruth Agenes Young Scholarships at the University of Maine at Machias for students whose grandparents or great-grandparents were members of Eastern Star, a scholarship for grandchildren and great grandchildren of full-time faculty (past or present) sponsored by the San Diego State University Retirement Association, a scholarship for grandchildren of alumni at Texas State University San Marco, a scholarship for children, grandchildren and great grandchildren of alumni at the University of New Hampshire, and a scholarship for grandchildren of alumni sponsored by the University of Pittsburgh Alumni Association. Some colleges also have scholarship funds restricted to students with particular last names, such as Zolp and Scarpinato. (See FinAid's list of unusual scholarships for these and other name-focused scholarships.)
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 David Adey Veterans Scholarship at the University of Baltimore for students whose grandparents served in Vietnam and the Marine Corps Scholarship Foundation. 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
Volunteering with your grandchildren can be a wonderful way of acting as a positive role model. It can also yield some money to help pay for college.
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 (P.L. 111-13) authorizes the Silver 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 and subsequent budgets.
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 not reported as an asset on the Free Application for Federal Student Aid (FAFSA). But distributions from such a college savings plan are reported as untaxed income to the beneficiary on the subsequent year's FAFSA. This has a more severe impact on aid eligibility than when the college savings plan is owned by the student or the student's parents. For example, section 529 college savings plans, prepaid tuition plans and Coverdell education savings accounts are not reported as assets on the FAFSA of a dependent student if they are owned by a grandparent of the student (or anybody other than the student or the student's parents). If the student is independent, however, such grandparent-owned 529 plans, prepaid tuition plans and Coverdell education savings accounts are not reported as an asset of the student. Only qualified education benefits owned by the student are reported on an independent student's FAFSA. The reporting of a qualified education benefit as an asset is based on account ownership, not the beneficiary, as the account owner can change the beneficiary at any time. Distributions from college savings plans are not reported on the FAFSA if the plans are reported as assets on the FAFSA. Otherwise the distributions are reported as untaxed income to the beneficiary on next year's FAFSA.
This change was effective starting with the 2009-10 award year. The College Cost Reduction and Access Act of 2007 (CCRAA) amended sections 480(a)(2), (f)(3) and (j)(2) of the Higher Education Act of 1965 effective July 1, 2009, to exclude distributions from 529 college savings plans, prepaid tuition plans and Coverdell Education Savings Accounts from income, assets and the definition of estimated financial assistance. This encoded previous subregulatory guidance published by the US Department of Education in Dear Colleague Letter DCL-GEN-06-10.
While some people have misread the law as excluding all distributions from qualified education benefits from the FAFSA, a careful read of the statutory language indicates that it excludes only distributions from college savings plans that are reported as assets on the FAFSA. Specifically, the exclusion in section 480(a)(2) of the Higher Education Act is limited to qualified education benefits that are "described in subsection (f)(3)". Section 480(f)(3) identifies the qualified education benefits that are reported as assets on the FAFSA.
The specific legislative language in sections 480(a)(2), (f)(3) and (j)(2) of the Higher Education Act of 1965 is:
(a)(2) No portion of any student financial assistance received from any program by an individual, no portion of a national service educational award or post-service benefit received by an individual under title I of the National and Community Service Act of 1990 (42 U.S.C. 12511 et seq.), no portion of any tax credit taken under section 25A of title 26, and no distribution from any qualified education benefit described in subsection (f)(3) that is not subject to Federal income tax, shall be included as income or assets in the computation of expected family contribution for any program funded in whole or in part under this chapter. (f)(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. (j)(2) Notwithstanding paragraph (1), a tax credit taken under section 25A of title 26, or a distribution that is not includable in gross income under section 529 of such title, under another prepaid tuition plan offered by a State, or under a Coverdell education savings account under section 530 of such title, shall not be treated as estimated financial assistance for purposes of section 471(3) of this title.
As such, college savings plans owned by a grandparent are disregarded as assets on the FAFSA, but distributions from such plans are reported as untaxed income to the beneficiary. This reduces aid eligibility by as much as half of the distribution from such a college savings plan, compared with at most 5.64% of the asset value of a college savings plan owned by the student or the student's parents. Thus 529 plans owned by a grandparent have a much more severe impact on eligibility for need-based aid.
(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 controlled 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. )
There are two main approaches to fixing the financial aid treatment of a 529 college savings plan owned by the grandparents. One is to change the account owner to the student or to the student's parents. The other is to delay taking a distribution until the student's senior year in college, when affecting next year's financial aid eligibility is no longer a concern. (Technically one can take the distribution any time after January 1 of the junior year in college.)
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 as a student asset.
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.
See Section 529 College Savings Plan Loophole for additional discussion of the treatment of qualified education benefits as assets and income.
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(c)(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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