Why Your Grandparents Could be Your Meal Ticket to College

Why Your Grandparents Could be Your Meal Ticket to 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.)

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(c)(1)(xiii)). This reduces need-based aid by 100% of the amount

of the direct payment, dollar for dollar.

Student Loans

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.

Roth IRA

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.

Source: Fastweb

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