It’s always wonderful when grandparents volunteer to 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.

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.

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

Grandparents, aunts, uncles, 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 also use a financial aid application called the CSS/Financial Aid PROFILE 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.

When grandparents eventually withdraw money from an investment account to use for their grandchild, parents must report this money as the child’s income on the FAFSA and PROFILE (if applicable) the following year. This income can reduce aid eligibility by as much as half of the cash withdrawn from the college account.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. The next year 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 2015-2016 school year, the allowance is $6,310. A student can earn $6,310 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.

Grandparents should be strategic when withdrawing money.

If financial aid is at stake, grandparents could wait to withdraw money until after the family has filed for financial aid in the late winter or spring of a child’s junior year in college.

Why then? Because this represents the last financial aid application the family will submit (assuming that the child graduates from college in four years). After that form is completed, a college will no longer ask about a family’s finances.

Contribute to a parent 529 account.

Another option for grandparents is to simply contribute to a 529 account that parents have already established. This way, all the assets will be assessed at the lower parent rate of 5.64%.

Move the 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 another individual.

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.

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