How to Minimize the Impact of a Student's Brokerage Account on Financial Aid

How to Minimize the Impact of a Student's Brokerage Account on Financial Aid

We have an UTMA mutual fund for our son who is a senior in high

school (17 years old). It is approximately $19,000 and was intended to

help pay for college costs. When we opened it we weren’t aware of the

impact it could have on financial aid. I realize it’s too late to fix

anything for his freshman year next year, but will it help him any for

his sophomore year if we take it out prior to the end of this tax

year? His other school money is in an educational IRA and won’t ding

him as much.

— D.G.

Custodial bank and brokerage accounts, such as UTMA and UGMA accounts,

are treated as a student asset on the Free Application for Federal

Student Aid (FAFSA). This has a more severe impact on eligibility for

need-based financial aid than parent assets. Student assets reduce aid

eligibility by 20 percent of the asset value. Some parent assets are

sheltered from the need analysis formula. The remaining parent assets

will reduce aid eligibility according to a bracketed scale, with a top

bracket of 5.64 percent.

Parents can fix such a situation by moving the student’s money into the

custodial version of a 529 college savings plan. Even though a

custodial 529 plan is technically the student’s asset, federal law

since 2009 has treated custodial 529 plan accounts as though they were

a parent asset on the FAFSA. (Prepaid tuition plans and Coverdell

education savings accounts are also treated as parent assets, but are

more likely to be affected by contribution limits.)

Parents can also spend the student’s money for the student’s benefit,

so long as the expenses are not normally considered parental

obligations, such as food, shelter and medical care. For example, if

the student will need a car or computer for college, the parent could

buy it with the student’s money. Parents can also spend the

student’s money for college costs, such as tuition and fees, room and

board, and books and supplies.

Since assets are reported on the FAFSA as of the application date,

parents can address the harsher treatment of student assets at any

time prior to filing the FAFSA, not just before the prior tax

year.

(Practically speaking, any changes in assets should occur at least a

month before filing the FAFSA. During verification, college financial

aid administrators may ask for copies of bank and brokerage account

statements, especially if the interest and dividend income on the

student’s income tax return is high compared with the student assets

reported on the FAFSA. Accordingly, any changes in the student’s

assets should occur early enough to be reflected in the most recent

statements prior to filing the FAFSA.)

However, contributions to a 529 college savings plan must be made with

cash, not securities. So to roll a student’s brokerage account into a

custodial 529 plan account, the parent must first liquidate the

brokerage account. If the stocks, bonds or mutual funds held in the

brokerage account have appreciated significantly, liquidating the

account will result in capital gains. Capital gains are treated as

income on the FAFSA. Student income received during the prior tax year

will reduce need-based aid eligibility by as much as half of the

amount of income. To prevent capital gains from affecting eligibility

for need-based financial aid, realize them before October 1 of the

junior year in high school.

Once the student is a senior in high school, however, there’s no room

to liquidate the brokerage account without having the capital gains

affect aid eligibility on the subsequent year’s FAFSA. It then becomes

a tradeoff between the treatment of the capital gains as income and

the treatment of the account as an asset. The student’s need-based

financial aid package will be reduced by 20 percent of the asset value

each year until the brokerage account is liquidated. If the money is

rolled over into a custodial 529 plan account, the financial aid

package will be reduced by up to 5.64 percent of the asset value each

subsequent year until the money is spent. When the brokerage account

is liquidated, the student’s need-based financial aid package during

the subsequent year will be reduced by up to 50 percent of the capital

gains.

Regardless of whether the money is spent on the student’s college

education directly or rolled over into a custodial 529 plan account,

the brokerage account must be liquidated. So realizing capital gains

is unavoidable. (One could avoid liquidating the brokerage account

until after the FAFSA is filed for the student’s senior year in

college. But then the student’s asset will reduce aid eligibility by

20 percent of the asset value each year, or a cumulative total of 80

percent of the asset value. That is not a cost-effective solution.)

This suggests that the optimal strategy for a student who is already a

high school senior is to liquidate the brokerage account immediately,

spend as much as possible of the student’s money on the student’s

education this year, and put the rest of the money in a custodial 529

plan account for subsequent years. The parent should not tap into any

of the parent’s money until the student’s assets are spent down to

zero.

Source: Fastweb

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