Helping your grandkids pay college tuition can only be a good thing, right?
Actually, it’s not quite as simple. In some cases, well-meaning grandparents can do some serious damage. A poorly advised contribution can compromise the amount of money the student might be getting from the school or the government as financial aid. It can also hurt your own retirement prospects. Before you take out that checkbook (or make a promise to do so), here are three common pitfalls to avoid.
Not understanding the full financial picture
For many families, paying for college involved weaving is a complicated web of personal resources, financial aid, scholarships, work-study programs, and loans. Simply handing over the money might do more harm than good.
And so, you must understand the student’s financial situation first. If your grandchild has received merit-based scholarships, they aren’t likely to be affected by your contribution. However, need-based financial aid is dependent upon assets and income reported by student and immediate family (i.e. custodial parent or parents).
The type of financial aid that your grandchild is counting on matters, too. Some need-based packages are a combination of free grants and subsidized loans that must eventually be repaid. Your money can eliminate the possibility of a need-based grant or reduce the amount of the award.
The actual impact of your choices will vary depending on the situation. If your resources only allow you to help pay freshman year tuition, your gift may disqualify the student from financial aid for sophomore or junior year. This could create considerable hardship for the family. If, on the other hand, the student was only going to receive a small loan, and if your financial situation allows for future contributions, eliminating student loans may be a good thing.
Bottom line: Make sure you have your arms around the full financial picture before you make your move!
Giving the money directly to the grandchild
Colleges expect students to contribute up to 20% of their assets to paying for their education (a 529 plan doesn’t count as the student’s asset). Parents are only required to commit 5.6% of their assets. Therefore, it is better to give the money to the parents because it may position your grandchild to qualify for more financial aid.
Consider contributing to the parent-initiated 529 plan instead of starting your own. Payments from the custodial parent’s 529 plan don’t count towards the student’s income, which can allow the student to get more financial aid. On the other hand, payments from a 529 plan sponsored by someone else (such as a non-custodial parent, grandparent, aunt, cousin, etc.) must be reported as student’s income. Colleges expect students to contribute as much as 50% of their income towards college expenses, so an $8,000 withdrawal from a grandparent’s 529 plan could potentially reduce financial aid by up to $4,000.
The same $8,000 payment from the parent-sponsored 529 plan would not affect financial aid at all. Of course, by contributing to a 529 plan maintained by the student’s parents you are forgoing the ability to control what happens to the money, but most grandparents are comfortable with that.
The timing of your gift can make a significant difference, as well. Any tuition help received after January of the grandchild’s junior year won’t show up on financial aid applications for senior year (because the student will have already filled them out). In some situations, it might make the most sense to save grandparents’ contributions until the student reaches the middle of junior year.
Not taking care of your own retirement needs first
One of the biggest mistakes a grandparent can make is helping a grandchild with college tuition before funding emergency savings and retirement accounts. We all want what’s best for our kids and grandkids, and it’s important to remember that ensuring your own financial stability is a critical part of taking care of your family. It is not “selfish” to make a contribution to your 401k or IRA first.
Also, think twice before applying for loans to help cover your grandchild’s tuition. You may have the financial resources to make the monthly payments right now. But an unexpected event (such as job loss or a medical diagnosis) might leave you struggling to make ends meet and potentially compromise your Social Security payments.
So, talk to a financial planner first. Make sure that you have all the facts, including the family’s current plan for covering college tuition. Think carefully about timing your contributions and keep a close eye on funding your own retirement needs. By using this approach, you can make a loving gift that will have the most positive impact on your grandchild’s life.