On the money

Saving money for college? Study aid rules

Q You recently warned a parent not to let his son open a Roth IRA because it could keep him from getting financial aid for college. We opened a UTMA account for our niece some time ago and wonder if that would reduce the amount of financial aid she could receive when she goes to college.

George and Toni, Illinois

A A UTMA, or uniform transfer to minor account, can be extremely detrimental to families who need financial aid. UGMA, or uniform gift to minor accounts, are, too.

If families think their income is low enough to qualify for financial aid, they should not open these accounts. If they already have a UGMA or UTMA, and know they will qualify for financial aid, they should consider getting rid of them before applying for college and filling out aid forms.

Unfortunately, too many families blunder their way into these accounts, in which assets are transferred to a child via a trust typically known as a custodial account. They are similar, but UTMAs allow more types of assets to be transferred.

Well-intending relatives often go to brokers or financial advisers, express a desire to help a child in the family save for college, and are directed into a UGMA or a UTMA.

But financial-aid rules are esoteric and few advisers or accountants understand them. When they apply the same strategies to middle-income families that they apply to their high-income clients, people of modest means can pay a huge price when it comes time to pay for college.

For example, say a student is about to start his freshman year in college. Finances are tight for his family. His parents are going to face about $20,000 a year in college expenses, and they aren't sure where they will come up with the money. The college has calculated that the family will need financial aid, and to help, the college will give the family $2,500 in grants -- free money that does not have to be repaid.

If the student had $10,000 in a UTMA account, however, the family could lose the entire $2,500 in grant assistance at some private colleges, and $2,000 at public ones, said Kalman Chany, a New York financial aid consultant and author of "Paying for College Without Going Broke." That's because of a quirky financial-aid formula that requires students to use 20 percent to 25 percent of any assets they have to pay for college.

The outcome would be very different if the same $10,000 in savings was held in a parent's account -- under the parent's name -- rather than in an account expressly devoted to the student. Then, Chany said, the college formula would only require parents to use $560 a year, or 5.6 percent of the assets, to pay for college. And the family would receive $1,940 more in grant money than they would using the UTMA.

There's logic behind this: The idea is that students can use all the money they have for college, while parents have other needs to fund, too. But the logic doesn't make much sense when parents are going to pay most of the college bill -- regardless of which pot of money they tap.

It gets worse. All of this is based on a formula. And roughly speaking, the formula assumes that the family will remove only $2,500 a year in the UTMA to pay for college each year. But if the parents are so strapped that they use the full $10,000 the first year, Chany says the college might still assume $2,500 is available for each of the next three years. So the family won't get grants that they otherwise might have received.

Keep in mind, however, that these concerns only apply to families who would qualify for grant assistance offered by colleges. Realize that most financial aid includes low-interest student loans, rather than grants.

Before trying to liquidate a UTMA in a panic, figure out first if the student you want to help is in a family that might qualify for grants. Generally speaking, if parents' income is much above $60,000 or $70,000 a year, they aren't likely to receive grants at public colleges in their home state, Chany said. For private colleges, opportunities start to dwindle when incomes rise above $150,000 to $200,000.

There are exceptions, however. Aged parents, disabled parents, and those with high medical costs can receive more aid despite relatively high incomes. Families with two or more students in college at the same time, or children in private schools, may receive more help because education expenses require so much of their income.

Also, do not worry about UTMA or UGMA accounts in 529 college savings plans. The current law treats them differently than other UTMA and UGMA accounts, Chany said.

Still, he does not suggest people with UTMAs convert them quickly into UTMAs in 529 college plans. Congress is evaluating the rules and may take action within a few months. So a family could make a needless change.

Also, before tinkering with accounts in a child's name, realize certain tax rules apply. If a family tries to liquidate a UTMA, selling stocks, bonds or mutual funds could result in a high tax bill. Depending on the size, and the amount of financial aid a family might receive, it could be worth it, Chany said.

Meanwhile, also remember that a UTMA or UGMA sets aside money for a child. So a relative cannot simply liquidate it and put the money elsewhere, Chany said.

Instead, he advises families that should liquidate these accounts to use the money for the child. It could fund camps, computers, clothes for special occasions like proms, and trips to explore colleges.

The key is to liquidate them before the student files college aid forms, known as the FAFSA or PROFILE, with colleges. Chany suggests getting finances in shape for college by the time families file their tax forms during a child's junior year in high school.

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Gail MarksJarvis is a Your Money columnist. Contact her at gmarksjarvis@tribune.com. For more on managing your money, see her blog at chicagotribune.com/money.

For a clearer understanding of what this means to your family, parents should try the "expected family contribution" calculator found at www.finaid.com (click on "calculators" to find it). Work both the "federal methodology," which is for public colleges, and the "institutional methodology," which is for private colleges. Different types of colleges have slightly different rules.
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