You might be wondering what gift to give a young person who is in college or planning to go in the next few years. Laptops, clothes or Amazon gift cards might be on many students’ lists, but help with paying for college is always appreciated. Just know that unless you are the student’s parent, there is a smarter way to help out than stuffing a stocking with a large check.
In fact, how and when you make your gift is vitally important. Giving a gift of cash directly to a niece, grandson or other young person, especially if you do so at the wrong time, could reduce the student’s financial aid. That’s because gifts from anyone but a parent are counted as income or savings.
When to Give a Student Money for College Tuition
To minimize any negative effects, wait to give the gift until the student’s senior year of college, or even after graduation, once all government and school grants and student loans have been awarded. Alternatively, you could give the money to the student’s parents to help them pay for the tuition, since parents’ assets play a smaller role in financial aid calculations than the student’s own savings.
A student’s eligibility for need-based financial aid is calculated according to a complex federal formula. Essentially, a student is expected to use 50% of any income she has, along with 20% of savings or other assets, such as stock, toward college costs each year. So for example, a generous cash gift of $30,000 while a student is enrolled in college would boost the student’s income by that same amount, meaning she would be eligible to receive $15,000 less in financial aid, using the 50% rule. (For related reading, see: A Quick Guide to How FAFSA Loans Work.)
The impact is much lower if the cash is given to the student’s parents, who are only expected to use 5.64% of their assets to pay for a child’s tuition, according to the federal formula. That means a gift of $30,000 to parents would reduce financial aid eligibility by $1,692.
The best approach is to give a gift that falls outside these nets. One way to do that is to adjust the timing of your gift. Instead of helping out your niece during her freshman year, pay for her last year of school. This way the gift won’t show up on her federal student aid paperwork, known as Free Application for Student Aid (FAFSA), which is completed prior to the school year. Be aware that some financial aid forms ask about expected gifts, so you need to be careful about not running afoul of the rules.
Another option is to wait until the gift recipient has graduated from college, and then use the gift to help her pay off her student loans. That way she will be eligible for the maximum amount of financial aid while in school, and she will be able to use your gift to pay off her college loans afterward.
How the Gift Tax Applies to Tuition Assistance
Tuition assistance also can be affected by a minor wrinkle called a gift tax. In 2018, whenever you give anyone other than a spouse more than $15,000, you have to file IRS Form 709, the United States gift (and generation-skipping transfer) tax form. You won’t actually have to pay any tax on your gift unless you have gone over your lifetime maximum of $5.6 million, but you will have to keep track of it.
If you want to avoid the IRS paperwork for your help with college costs, you could give the gift directly to the educational institution in the student’s last year. The gift will qualify for an exclusion under Internal Revenue Code §2503.
Why 529 Plans Are a Popular Way to Help Pay for College
Some friends and relatives help out with tuition by setting up a 529 plan. These popular plans make sense for children who are years away from starting college because the gains grow tax-free. Funds in a 529 plan can be used to pay for tuition and fees. These plans are great if you have many years before the student goes off to college, but they have the same effect on financial aid eligibility as any other savings. One solution is to transfer the 529 to a parent’s name and let him or her make the distributions with the 5.64% penalty. Note that a few states have limits on transferring ownership of a 529 plan.
So, feel free to give the gift of college tuition. Just do it wisely.
(For more from this author, see: How to File and Suspend Social Security Benefits Online Before Deadline.)