In the world of college financial aid, good estate planning strategies often result in less financial aid for your child. For instance, a strategy included in many estate plans involves making annual tax-free gifts to children.
Annual gifts can be made up to $15,000 or $30,000 if the gift is split with your spouse, to any number of individuals with no gift-tax consequences in 2021 (and 2020). Once the gift is made, the assets are removed from your taxable estate and any income on the gifts is taxable to the recipient.
The problem results from how assets are treated for financial aid purposes. To determine your financial aid amount, a college takes the cost of attending that college less your expected family contribution (EFC). When calculating your EFC, the college considers your income and assets as well as your child's income and assets. While certain assets are excluded from this calculation, such as retirement funds and annuities, a maximum of 5.6% of the parents' assets and up to 47% of the parents' income are included in the EFC, while 20% of the child's assets and up to 50% of the child's income is included.
The difference between 20% of your child's assets and 5.6% of your assets can make a big difference in your financial aid award. For example, suppose you and your spouse have been making $20,000 gifts to your child for the past five years, so your child now has $100,000 of assets. For financial aid purposes, your child will be expected to use $35,000 of those assets toward college, so he or she probably won't receive any financial aid unless going to a very expensive college. On the other hand, if you still owned the $100,000 in assets, you would be expected to use a maximum of $5,600 toward college costs.
Thus, before starting an annual gifting program, consider the possible impact on financial aid calculations. Become familiar with financial aid formulas, roughly calculating what you could expect in terms of financial aid. You should also consider what college your child is likely to attend and other relevant factors such as potential scholarships.
If, after going through the calculations, you find you probably won't be eligible for financial aid, you may decide to make annual gifts to your child. However, if the calculation indicates you may receive financial aid, you might want to hold off on an annual gifting program.
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