The rules surrounding need-based financial aid can be confusing and overwhelming to most. In their recent article "Grandparents and College Planning — the Right Way," Nerd Wallet looks at some ways that grandparents can help pay for college without negatively impacting their grandchildren's eligibility for need-based aid.
529 Accounts. These are a very popular college savings vehicle. The combination of tax benefits and flexibility makes them a good choice for many folks. It is essential to understand the impact of account ownership and the timing of distributions on financial aid.
If grandparents contribute to a 529 account in a parent's or grandchild's name, the 529 account counts as a parental asset under the guidelines of the Free Application for Federal Student Aid. As a result, those monies may reduce the amount of aid for which the student is eligible. Typically, it's wisest to establish the 529 plan in the grandparent's own name so it won't impact need-based aid eligibility on the FAFSA.
You also need to be cautious when making 529 distributions. Although parent-owned 529 plans are included in aid calculations, qualified distributions used to pay for the student's education expenses are not included for the following year. But grandparent-owned distributions are considered "untaxed income," which can reduce a student's aid award. If grandchildren aren't going to attend graduate school, take the distributions when they are in their junior or senior year of college because of the new "Prior-Prior" rules that use the student's sophomore year as the final "base" year for assessing aid eligibility.
Gifts. When it comes to financial aid, grandparents should use caution with gifts because gifts given to grandchildren or directly to the school will be deemed "unearned income." This could decrease the amount of their award. The best time to make gifts is in the grandchildren's junior or senior year of college. If they aren't going to grad school, gifts received in the last two years of college are not counted in aid calculations.
In the college-planning process, first determine if your child qualifies for need-based aid at the schools of his or her choice. If not, then it doesn't matter who owns the assets, receives the income, or when the gifts are made for aid purposes. Next look at merit aid and tax aid—such as the American Opportunity Tax Credit—and how to best use personal resources to pay your share of the expense.
College is a great investment, so be proactive and plan accordingly.
Reference: Nerd Wallet (February 9, 2016) "Grandparents and College Planning — the Right Way"