The catch is that the government prorates large gifts made by donors that use the accelerated gift option. A $50,000 gift made this year from Grandma will be averaged out and considered a $10,000 gift each year for the next five years. If Grandma wants to donate an additional $5,000 next year, the IRS will look upon that amount as $2,000 above the $13,000 gift tax exclusion, even though the total of her gifts from both years is well under the $65,000 accelerated gift option limit. While Grandma won't owe gift tax, she will have to file the gift tax form accounting for the $2,000 overage.
There's another benefit to gifting into a 529. Besides offering a lower assessment rate, 529 funds can only be withdrawn by the account holder. If Junior decides that a Caribbean cruise is better than attending college, he can't use your 529 plan account money to take the cruise.
Think outside the FAFSA formula
If the student is receiving sizable need-based aid and your gift isn't large enough to incur gift tax, put the gift into a savings vehicle that's outside of the financial aid formula.
"A (permanent) life insurance policy is completely off the radar screen for financial aid purposes," says Martin L. Greatorex, a certified college planning specialist and owner of The College Navigator, a college planning firm in Milford, Conn.
According to the Department of Education, funds stored in a cash value life insurance policy won't count against a student in the federal financial aid methodology, provided that the student withdraws the money by taking a loan against the account rather than surrendering it. Should the student surrender the account, any money taken out will count as income and will subtract from their financial aid package by up to half.
Greatorex adds that relatives can also donate to a Roth IRA held in the student's name. To have a Roth IRA, students need to have earned income and can only contribute up to the maximum amount that they've earned, or $5,000 per year, whichever is less. Parents can put their own money in the IRA account for the student as long as the student meets the income requirements. Students can pay for college using contributions to a Roth but must wait five years before withdrawing earnings.
Like life insurance plans, Roth IRAs aren't counted in the federal aid formula. The amount of aid is determined based on a student's income and asset levels from the previous year, so Roth savings won't count against students in their freshman year. But once students start taking withdrawals, money pulled from a Roth counts as income from a financial aid standpoint and can heavily impact the student's aid package for subsequent years, according to the Department of Education.
Darvis says that relatives can avoid the financial aid ding by setting up a monetary gift as a "loan" that they plan to forgive after the student has graduated. Or they can save it for the student's final school year, when other financial aid sources tend to run dry.
By gifting with financial aid in mind, gifts go further and grads come closer to a debt-free college tenure.
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