For high school seniors, May and June bring about thoughts of graduation and hopes for the future. Meanwhile, family members think about how to financially reward their college-bound offspring. But a substantial gift may impact a freshman college student's financial aid package. Consider these ways to give a graduation gift that won't negate financial aid.
Don't hand over cash or checks
Giving money to the student is one of the fastest ways to obliterate their aid package, says Rick Darvis, co-founder of the National Institute of Certified College Planners in Plentywood, Mont.
"A cash gift from (anyone) other than a parent is reported as income on the (federal) financial aid form," says Darvis. "(Student) income is assessed at a 50 percent rate. That means that a gift of $10,000 could potentially cost $5,000 in financial aid."
The Free Application for Federal Student Aid, or FAFSA, asks a pointed question in the "student's untaxed income section." It wants to know the amount of: "Money received, or paid on your behalf (e.g., bills), not reported elsewhere on this form." This includes cash gifts from grandparents, noncustodial parents and anyone outside the immediate family. Cash gifts given from these sources directly to the student subtract 50 cents in need-based federal aid for every dollar given. Gifts from custodial or married parents to students are counted as a student asset and subtract 20 cents to 25 cents in financial aid for every dollar given.
The FAFSA bases your federal financial aid package on your financial status from the year before. If students receive a cash gift after filing the FAFSA, the gift won't immediately impact their aid package, but it will subtract from next year's award.
Darvis admits that tracking such gifts is difficult. Though cash gifts to students frequently go unnoticed by the Internal Revenue Service, getting caught comes with penalties. According to the Department of Education, families caught omitting information on their federal financial aid application could face fines of up to $20,000 and jail time.
Don't pay institutions, either
Paying the school directly is a no-no, too, says Jim Lundgren, CEO of Access College Foundation, a nonprofit college education organization in Temecula, Calif. When colleges receive checks from benevolent relatives, Lundgren says that they regard those funds as outside resources and can subtract money dollar for dollar from a student's aid package.
"If your school offers you a $10,000 grant and they see that you have $10,000 coming in, they can take that grant away," Lundgren says.
While handing cash to either the college or the student can result in repercussions, noncash gifts such as a car, laptop or school supplies aren't assessed at all, says Darvis.
Invest in 529 plans with caution
Even dropping funds into a 529 plan could cause the family to lose financial aid. In the federal aid formula, the government takes away up to 5.6 cents in aid for every dollar stored in a 529 account in the parent's or student's name, according to the Department of Education. A 529 account held by grandparents or other relatives won't be factored into the federal formula, but will be considered by private colleges who use the CSS Profile methodology to determine aid eligibility.
Gifts stored in a checking, savings, UGMA or UTMA account held in the student's name can subtract up to 25 percent from a student's aid package. By contrast, 529 accounts subtract far less and could carry benefits for the donor as well as the beneficiary. Don Roberts, a Chartered Financial Consultant with Sapient Financial Group, a financial services firm in Austin, Texas, says that gifting in a 529 can make sense for aging relatives looking to lighten their estates.
"Right now you can gift $13,000 per year per individual," without worrying about gift tax, says Roberts. "With a 529 plan, I can actually contribute up to five times that amount at once. That means I can move up to $65,000 out of my estate without paying a gift tax."
Under current law, a gift of $13,000 or less qualifies for the annual gift tax exclusion, meaning the recipient does not pay income taxes, and no IRS tax forms need to be filed. The 529 plans come with an accelerated gift option that allows donors to gift up to five years' worth of annual contributions at once without incurring gift tax. According to the IRS, individuals can gift up to $65,000 per beneficiary while married couples can gift up to $130,000 to a student without any gift tax ramifications.