Grandparent Savings and Financial Aid

It’s always wonderful when grandparents can help with college costs.

Grandparents, however, have to be careful about how they pitch in if their grandchildren have a shot at receiving need-based financial aid.

Friends of mine experienced first hand how grandparent generosity can backfire. Their story is an extreme example, but there are lessons here for other families as well.

When the three children of my friends were young, the grandparents gave each of their grandchildren a significant amount of money in trusts. The grandparents intended each of the children to eventually use the money to help buy a house in San Diego, one of the nation’s most expensive real estate markets.

The dad and mom are middle class, but the money in the children’s names eliminated their chances of receiving financial aid. The children were bright and probably would have been admitted to some excellent private schools that offered strong aid packages if the grandparents hadn’t made those early gifts.

If the children had attended private colleges, it would have come out of their house funds that no one in the family considered tenable.

All three children ended up attending state universities in California and paying full fare.

If the grandparents had kept the money until the children graduated from college, their school choices would have expanded greatly.

What You Need to Know When Grandparents Want to Help

1. If you won’t qualify for need-based aid, there is no issue.

If your family is too affluent to be eligible for need-based financial aid, it doesn’t matter how grandparents save for college or how they help pay the tab.

Grandparent contributions only jeopardize need-based aid and not merit scholarships. Schools award merit scholarships regardless of need.

2. Grandparent savings won’t hurt as long as the money isn’t used.

Grandparents, aunts, uncles or other relatives or family friends can save for college without jeopardizing a child’s chances for financial aid as long as the money stays in their accounts. These can be 529 college savings plans or other investment accounts.

The Free Application for Federal Student Aid does not inquire about third parties saving for a child’s college education.

Except in rare cases, schools that use the CSS/Financial Aid PROFILE also do not ask about non-parents holding money for a student. Those schools that do ask about outside accounts intended for the child can decide to assess that money any way they wish.

3. Withdrawn money does count against a child.

When grandparents eventually withdraw money from an investment account to use for their grandchild, parents must report this money as the child’s untaxed income on the FAFSA and PROFILE (if applicable). They are expected to originally report this money on the child’s income tax return.

This income can reduce aid eligibility by as much as half of the cash withdrawn from the college account.

Let’s say a grandmother contributed $10,000 to help defray her granddaughter’s tuition cost. When the family was completing the FAFSA, the parents would have to declare this gift.

This contribution would be treated as the child’s income and be assessed at 50%.

$10,000 X 50% = $5,000

Based on the formula, the child’s financial aid eligibility would drop by $5,000. Put another way, the child’s EFC would rise by $5,000.

The FAFSA does provide a way to help blunt or eliminate the penalty triggered by a grandparent’s largesse. The FAFSA gives each student an automatic income allowance that is adjusted annually. For the 2017-2018 school year, the allowance is $6,420. A student can earn $6,420 without having his or her income subject to the 50% assessment.

Consequently, in this example the student’s income allowance would help blunt the impact of the grandparent’s $10,000 gift to help pay her college costs.

4. Grandparents should be strategic when withdrawing money.

If financial aid is at stake, grandparents should be strategic about when they help. Federal regulations implemented in 2016 has made it easier for grandparents to help earlier and not jeopardize a grandchild’s chances for financial aid, which is great news for families.

Here’s why timing is important. The FAFSA and PROFILE asks if anyone beyond the parents has contributed to a child’s college costs in the base year. Traditionally, the base year had been the calendar year before the child starts the new school year. For a student who was enrolled in college in the fall of 2016, for example, the base year was 2015. Consequently, if a grandparent helped with college costs in 2015, that would have been reported on the FAFSA for the 2016-2017 school year. And this money, as you’ve already learned, would have been treated as the child’s income.

Because of this rule, grandparents had traditionally been told to ideally hold off on helping until the last financial aid form has been filed. This has typically been in the late winter or spring of a child’s junior year in college. After that form was completed for the child’s senior year aid package, a college would no longer ask about a family’s finances.

The base-year rule, however, has now changed that allows grandparents to help out earlier than in the past. Parents and students are now using their prior-prior IRS returns when applying for financial aid. This means the base year is not  the most recent calendar year completed prior to the start of the school year, but two calendar years prior.

Because the parents and students are using two-year-old tax returns, grandparents could safely start helping with college costs after the family has filed for financial aid for the upcoming junior year. Parents can now file for aid for the third year of college as early as October 1 of the child’s sophomore year in college.

PROFILE schools are also using two-year-old tax returns and allowing families to file for aid as early as Oct. 1.

5. Give parents money.

Another way to avoid the draconian grandparent penalty is for grandparents to simply give their adult children a cash gift, but this strategy is only recommended if applying to FAFSA-only schools.

The FAFSA formula doesn’t treat gifts to parents as untaxed income. In fact, the financial aid form doesn’t even ask if the parents received money from outside people or have had bills paid on their behalf.

Instead, the FAFSA just wants to know how much nonretirement assets that parents have on the day the aid application is filed. So if the grandparents give parents money after the aid application is filed and the parents spend it on college before the next FAFSA is filed, there will be no financial-aid hit since the money is gone.

This method won’t work with the PROFILE because the aid application asks parents this question each year:

Enter the amount of cash your parents received and any money paid on their behalf (e.g. bills). (Don’t include child support or any other amounts reported elsewhere on this application.)

If grandparents gave money to parents, this amount is supposed to be divulged on the PROFILE. As a practical matter, most parents won’t even know to share any money they received from grandparents or other generous sources.

6. Move money to the child’s parents.

A grandparent with a 529 plan could transfer the ownership of the account to a 529 account controlled by one of the parents of the child. Once the transfer is made, the money is treated as a parent asset which is assessed at no more than 5.64%.

About a half dozen states, however, only allow a change in 529 account ownership if there’s a court order or the owner dies. This restriction, by the way, is different from a change in beneficiaries which you can do in any state. For instance, if money is remaining in a 529 account when a student graduates, the owner (parent, grandparent or someone else) can change the beneficiary to someone else.

7. Lend money to the parents.

If parents borrow money from grandparents to pay for college, the debt won’t hurt financial aid chances. The loan, however, has to represent a legitimate lending arrangement and the grandparents need to charge interest. Once the parents are done paying for college, the grandparents do have the option of forgiving the loan. Parents should contact their tax professional regarding how any forgiven loan balance would be treated for tax purposes.


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  1. Lynn, I always find the “rule” for grandparents contributing to a grandchild’s education (so that those contributions are not considered income for financial aid purposes) to be a little confusing. Here is what I think the rule is – would appreciate it if you could confirm:

    Grandparent can contribute during the calendar year starting with January of the grandchild student’s sophomore year (assuming the financial aid forms for junior year have been filed), provided that those contributions are used to pay for college expenses before the next financial aid application (for senior year) is filed. I say this because although those contributions would not show up as INCOME in the tax return to be used for senior year financial aid, if the money was not actually spent for some reason for college, then it could show up as ASSETS in the grandchild’s or parent’s asset accounts when they file for financial aid senior year.

    Here’s my example: Granddaughter, a college sophomore, applies in October 2017 for financial aid for the school year 2018-2019 (her junior year). She uses the 2016 tax return (prior prior year to 2018). Grandfather contributes from a 529 account he owns with Granddaughter as the beneficiary pulling the funds in July 2018 to pay for college tuition due for fall 2018, Granddaughter’s junior year. Granddaughter then applies in October 2018 as a junior for financial aid for the school year 2019-2020 (her senior year). She uses the 2017 tax return (prior prior year to 2019). Grandfather’s contribution was made in 2018 so it’s not income in that 2017 tax return, and the tuition bill has already been paid using those contributions, so there are no assets to report sitting in Granddaughter’s or her parents’ accounts. Once the last financial aid application has been made (as a junior for senior year), the timing of contributions from the grandparent doesn’t really matter going forward.

    I think the foregoing makes sense (please confirm in case I’m overthinking this), but I also think it shows how you have to be careful timing-wise between sophomore and junior years, and that it would benefit grandparents and parents alike to coordinate their efforts when it comes to college funding. Personally, I think for grandparents with 529s it’s easier to just transfer ownership to the grandchild’s parents (provided your 529 is transferable, and I believe most are transferable).

    1. Post

      Hi Karen,

      To avoid jeopardizing need-based financial aid, grandparents should help pay for college after the parent has filed for financial aid for the child’s junior year in college. That could happen as early as Oct. 1 of the child’s sophomore year in college. This is great news for families. The ability to help pay for college without financial aid consequences so early in a child’s college years is thanks to the use of prior-prior tax returns.

      The reasons why tax returns are an issue is because the use of a 529 withdrawals by a grandparent or any other owner beyond the parents and child to pay for college is supposed to be declared on the child’s income tax return as untaxed income. As a practical matter, most parents wouldn’t even know to declare this money!

      Grandparent 529 withdrawals should not impact a family’s assets. I would not have the grandparents pull the money out of the 529 until it is ready to be used. And it needs to be used for college in the year that the money is pulled out. This money should not be sitting in a parent’s bank account when they must declare their assets on the aid applications.

      I hope that helps!

      Lynn O.

  2. Lynn, my parents bought EE savings bonds in hopes of using the money tax free toward my two children’s college expenses. I think the tax exclusions are being phased out, although some bonds (according to year purchased) can be cashed out for education purposes with limited (or no?) taxes owed if the owner’s MAGI is beneath a certain threshold ($77 – 91K in 2014). Otherwise, I think they will be taxed on interest earned, although I’m not sure of exact rate (based on their tax bracket?)

    So, I’m trying to determine how to use the funds strategically over time for both children (6 years apart in age; eldest a HS senior) without losing a lot in taxes now (for eldest child) or later (for younger child) or increasing our EFC.

    Not sure if we can or should take money out in 5 or 10K increments, or larger lump sum (50K)?

    Assuming my parents loan us money in first year of college (based on those funds) or “gift” us money after our Oct. 1st FAFSA is filed sophomore year of college, can we take out money in 8 -10K increments? Or larger lump sum?

    If tax exclusions are going away for EE bonds, is there any way to move them into a custodial 529? (Grandparents) Especially for our youngest? Or would this result in a double tax hit? (Tax on bonds, then federal tax on 529).

    I’ve tried contacting Paula Bishop and haven’t heard back from her. Many thanks for any advice!

  3. Hi Lynn-
    It sounds like for parents who could qualify for financial aid that it is better for the parents to be the 529 account owner (not grandparents). Is that right? Can the owner be switched now or is there a look-back period?

    What if the parents have substantial assets– is it better for the account owner to be the parent or grandparent?


    1. Hi Barbra,

      In most states, a 529 owner, such as a grandparent, can transfer the account to a parent. There are a few states where owner transfer isn’t possible. The 529 owner can contact his/her 529 provider and ask if it is possible.

      If the parents have substantial assets it is often likely that the parents also have high income. And in this case, it’s unlikely that need-based aid is a possibility regardless of what parents do. It is important for parents to run an EFC calculator to determine whether need-based aid is even likely. If it isn’t, it doesn’t matter who owns 529 accounts.

      Keep in mind that the new FAFSA/PROFILE rule on using two-year old tax returns means that grandparents can now safely help with college costs after the child’s parents have filed for financial aid in the second semester of a child’s 2nd year of college. That will be a tremendous help for families, who would otherwise qualify for financial aid, and want to count on generous grandparents.

      Lynn O.

  4. Hi Lynn,

    Do I have your permission to share this article with a client I am working with?

    If not, I understand as it is a protected document.

    Thank you.

  5. Above you make the statement “About a half dozen states, however, only allow a change in 529 account ownership if there’s a court order or the owner dies”. Do you know which six states these are? Most interested to know if California is one of the states.

  6. How does the new FAFSA rules (for a student entering college for the 2017-2018 school year) effect the timing when a grandparent should help with payment?

  7. If grandparents loan money to a grandchild, does FAFSA and PROFILE treat this as an asset of the grandchild, even though there’s a corresponding liability that cancels out any increase in net worth, thereby reducing financial aid? If so, then is the solution to fund the loan after the date the FAFSA and PROFILE forms are completed?

    1. Hi Robert,

      If there is money in a child’s account on the date of the PROFILE or FAFSA filing, that money must be declared. People can time the filing of the FAFSA/PROFILE for a date when the money isn’t in the account or there is less of it.

      I think the ideal solution would be to wait until the parents have filed the FASFA and the PROFILE during the child’s sophomore year in college and after that grandparent contributions for college won’t be counted. And actually, now that I think about it, the grandparents wouldn’t have to wait until the second semester of a child’s sophomore year in college because parents will now be able to start filing the FAFSA and PROFILE with two-year-old tax info beginning Oct. 1.

      If you want to consult a professional about your personal situation, I’d suggest contacting Paula Bishop, a CPA in Bellevue, WA and national financial aid expert, who I’ve referred many people to. Her web site is

      Lynn O’Shaughnessy

  8. Instead of grandparents lending money to a parent as discussed per tip No. 7 above, why not lend directly to the student/grandchild? If there are several grandchildren, that would seem to allow for multiple annual gift tax exclusions, should the grandparents decide to forgive the loans after graduation. If this works, then it would seem you could use direct loans to help finance the first two years of college and outright gifts thereafter as per tip No. 4 above. What do you think?

    1. HI Robert,

      I would talk to an accountant about this possibility.

      I want to emphasize that grandparent help is now far less complicated because of the new prior-prior year financial aid change that kicks in for the 2017-2018 school year. Families can start applying for financial aid for this future school year beginning on Oct. 1, 2016.

      Because of the use of two-year-old tax returns, grandparents can feel free to help pay for college without any financial repercussions after parents have filed for financial aid in the second semester of their child’s sophomore year in college. Previously, it was safe for grandparents to help with college costs after parents had filed for aid in the second semester of a child’s junior year in college.

      Lynn O’Shaughnessy

  9. Hi George,

    Your in-laws could lend money to you and your wife. As I mention above, it needs to be a legitimate loan and they need to charge interest. They can forgive the loan later. That might be the cleanest way to do this.

    If your in-laws put $10,000 into your 529 account, it wouldn’t be a problem with the FAFSA but I don’t know if you would have to disclose this on the PROFILE because of the question the PROFILE asks that I mention above. I would call the PROFILE and ask this question. This is the phone number:

    I’d love to know what you find out.

    Lynn O’Shaughnessy

  10. My in-laws want to help their grandchildren by “lending” them money for college interest-free so that they aren’t saddled with thousands in student loans when they graduate. We have set up 529 plans for each of our kids that will provide modest help ($5000-$10,000 per year) once they are in college. Our son who is graduating from HS in May has already earned merit aid at a few colleges he’s considering that when coupled with the 529, other cash contributions we can contribute, a $5500 federal student loan he will most likely qualify for, will leave approximately $10,000 per year for his grandparents to “loan” him to cover everything. It sounds like they should contribute the $10,000 in this example each year into the 529 plans that we as parents have set up in order to minimize any negative impact from their contribution towards his college? Rather than just give him the $10,000 contribution directly? Correct?