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A life ends and a college education begins

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My mother-in-law recently passed away, naming my wife as a beneficiary of her annuity. Our oldest child is a junior in high school and preparing to apply for college — and financial aid to pay for it — next year. How will the inheritance impact his availability for financial aid? Should we wait to file the claim form for the annuity until after the financial aid package is awarded, which the annuity company says is possible? Or should my wife disclaim the inheritance entirely and let it pass to the other siblings?

This is an excellent question highlighting the intersection between estate planning and financial planning for college.

There are two basic types of financial aid: need-based and merit-based. This brief article focuses on need-based aid. Eligibility for this aid is based on a static formula: cost of attendance minus expected family contribution = need. This is the amount that the college expects the student’s family to pay for school. The expected family contribution is calculated based on a snapshot of assets and income available for college.

Just like with real estate appraisals, there are three methods used to calculate expected family contribution. All three of them are based on the data of the income and assets of the student and parents, all of which must be reported on the Free Application for Federal Student Aid.

In Medicaid planning, the terminology is “exempt” and “non-exempt” resources. The concept applies in financial aid, too. Retirement accounts are exempt assets, as is a home. Non-retirement assets are included in the expected family contribution calculation. Home equity, small businesses, and non-qualified annuities are not counted in one calculation, but they are in the other two. Annuities and life insurance contracts are not reported on the application, but annuities are counted on the CSS Profile, which is the other aid form used by many private colleges. Not only will the asset value of investments be reported, but the unearned income such as interest, dividends, and capital gains will also impact the income calculation.

Under one of the three Free Application for Federal Student Aid calculations, home equity is capped at 1.2 times the parent’s adjusted gross income. Life insurance cash values and personal assets (household goods, cars, furniture, etc.) do not count under any of the three formulas.

The three aid formulas weigh income more than assets to determine what families must contribute toward the cost — it effectively expects parents to use 47 percent of their net income after taxes and other items. In other words, income counts nine times more than assets do.

Parents are assigned a “savings allowance” to arrive at an available asset value. In other words, after yet another calculation, parents are expected to use up to 5.64 percent of the available assets as calculated on college costs annually. Students, however, are not given a “savings allowance,” and 100 percent of the value of any asset in the student’s name is counted and expected to be used toward the college cost. In other words, the money in the student’s name is expected by the college to be used to pay tuition at a much higher rate than parents’ own assets. This is counterproductive to a common estate planning technique of utilizing the annual exclusion gift amount to make annual gifts to children, either in an Uniform Transfers to Minors Act, an Uniform Gifts to Minors Act, or a trust. This fact undercuts the wisdom of placing money in one of these accounts for the child. The student’s assets are calculated at about 20 percent for expected family contribution, while parents’ assets are calculated at five percent. From that standpoint, the 529 Account or a Roth (or a Coverdell if the parents’ income permits) is a better vehicle for stockpiling savings.

The 529 plans owned by the parent or student do not count toward the eligibility. The distributions might count toward income if someone owns the plan other than the parent or student, say, a grandparent, and distributions from a grandparent’s account do count as income for the previous year for financial aid purposes. When the 529 plan is owned by the parent or student, however, the distributions are not reported as income when applying for financial aid. The distribution is tax-free (because it is paying for education), is not reported on the Form 1040, and does not get reported as “untaxed income” on the financial aid application.

One advisor recommends waiting to use a grandparents’ 529 plan money until after the student’s final eligibility for financial aid has been determined, or in the student’s senior year, because the income will be reported for the prior year — the year the student graduates.

Trust distributions, on the other hand, are always counted as taxable or untaxed income and do count against eligibility for financial aid.

As for the second question on timing of estate distributions, one commentator suggests that the money is not reported as an asset on the Free Application for Federal Student Aid unless and until the estate is settled and the money is distributed.

Likewise, the commentator suggests, if ownership of the assets is contested (say, in a contested accounting in Surrogate’s Court), and the ownership has not been resolved, then there is also no requirement to report the asset on the application. Similarly, proceeds from life insurance would not be reported as an asset until received. Presumably this puts some level of control in the hands of the applicant or his parents as to when they submit the life insurance claim form, or perhaps coordinate with a friendly fiduciary (or contest an accounting) to control the timing for application purposes.

There is no “look back,” however, and an account owner can simply change the name of the beneficiary if the 529 plan will interfere with the ability to obtain financial aid, and if the financial aid package is more attractive than the funds held in the 529 plan.

But before you start moving money around in the years leading up to your child’s entry into college, consider the tax consequences of moving money around between owners. You will consume a portion of your federal lifetime credit, not to mention potential capital gains consequences. Selling appreciated investments will cause your income to spike, thus further disrupting the income calculations that will determine financial aid eligibility.

And, restructuring assets may be irrelevant if your and your spouse’s income will disqualify your child from financial aid regardless of where and how your assets are titled. If your income is $250,000, your expected family contribution will be approximately $65,683 which means your child is not likely to qualify for any need-based aid.

On the other hand, if you have two children in college at the same time, your expected family contribution is split equally among the two (or more) students. Although the prospect of having not one but two children in college at the same time invokes terror in the hearts of most parents, perhaps it has a silver lining in the financial aid arena. With more than one child attending college simultaneously, they may be eligible for need-based aid even despite a high income level.

Alison Arden Besunder is the founding attorney of the law firm of Arden Besunder P.C., where she assists new and not-so-new parents with their estate planning needs. Her firm assists clients in Manhattan, Brooklyn, Queens, Nassau, and Suffolk Counties. You can find Alison Besunder on Twitter @estatetrustplan and on her website at www.besunderlaw.com.

Updated 4:57 pm, July 9, 2018
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