Working the System – Parents Giving Up Custody of Their Kids to Get College Financial Aid

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Aunt Becky’s legal woes arose from her efforts to get her children into the University of Southern California. However, for many families, the problem isn’t getting their kids into a college of their choice, the problem is paying for it.

Some enterprising parents in Illinois reportedly have given up custody of their children to help them get college scholarships. According to a news story at Probublica online, dozens of wealthy families in Illinois have given up legal guardianship of their children so the teenagers can claim dramatically lower incomes and earn need-based financial aid.

When the guardianship proceeding is completed — usually during junior or senior years of high school — students are able to declare themselves financially independent on college applications. In one instance detailed by the Wall Street Journal, a student whose parents owned a $1.2 million home only had to declare $4,200 in income from a summer job. That student was able to obtain about $47,000 in scholarships and federal Pell grants to attend a private university that costs $65,000 per year.

The practice is legal, but the United States Department of Education is looking into the matter. And some universities are pushing back against the practice, reducing university-based financial aid awards to some students.

The article notes that laws in Illinois governing the transfer of legal guardianship are broadly written and that as long as the parents, children and the court agree, a judge can approve the transfer even if parents are able to financially support their kids. It’s not clear if the tactic has been tried in other states.

You can read the entire Propublica article here.

Saving for College Off the FAFSA Radar

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Many of my clients have a desire to incorporate a college savings component into their financial plans to help with their grandchildren’s college education expenses. In many cases, a 529 college savings account has already been set up for the grandchild by the parents, and the client would like to contribute to that account. Simple yes, but there is a better way.

First, any person who wants to save for a college education should consider using a 529 college savings plan. “529″ is the section of the Internal Revenue Code that makes tax-favored college savings accounts possible. Under section 529, funds contributed to a 529 account grow on a tax-deferred basis, and may be withdrawn tax-free if the funds are used to pay for qualified education expenses in the year the expenses are incurred.  “Qualified education expenses” include tuition, fees, books, supplies, and equipment required for the enrollment or attendance of the account beneficiary at an eligible educational institution (most colleges and universities, public or private).  A section 529 account may be set up by anyone who desires to save money for college expenses, including a grandparent for a grandchild.

A grandparent who sets up a 529 account for a grandchild gets the tax-advantaged savings, but there’s another benefit for the grandchild: Funds in a 529 account established by a grandparent will not affect the grandchild’s eligibility for student loans, grants, work/study programs, and even scholarships.

The vast majority of college bound students must fill out the Free Application for Federal Student Aid (“FAFSA”). The FAFSA identifies those assets that will be taken into account to determine a student’s financial aid eligibility. Financial aid eligibility is typically determined from the student and parents’ income and assets disclosed on the FAFSA (including 529 accounts established by the parent or student). Money contributed by a grandparent to a 529 account in the student’s name or in the parent’s name will be counted against the grandchild on the FAFSA.  Thus, the grandchild is penalized for the grandparent’s generosity.

However, the student’s FAFSA does not consider the assets of a grandparent. So, a grandparent may establish a 529 account in their name for a grandchild and the account is not reported on the grandchild’s FAFSA. The grandparent is able to put money away for a grandchild’s college education, without penalizing the grandchild.   In addition, the grandparent still controls the funds in the account. If the grandchild decides to not go to college or she receives substantial scholarship awards, the grandparent may substitute out one grandchild for another as the account beneficiary.

Each state must set up its own section 529 program, and nearly all the states have done so. But you can establish a 529 account in any state, not just the state of your residence. These programs are state-specific, and they have differing contribution limits, investment options, and costs. Some states (including Michigan) offer income tax benefits for their residents who use the Michigan 529 plan. So it pays to research carefully before opening a 529 account.

Are you thinking about setting aside money for your child or grandchild’s college education? Give me a call, I can help.

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