By Dave Coen
Inheritances are bittersweet—the last generous gift we receive from a loved one. And while they are meant to help us financially, they also have the potential to do damage if not handled correctly.
See, receiving an inheritance can influence your child’s financial aid eligibility. Depending on the size of the inheritance, your child may lose the opportunity for federal grants and be forced to take on more student loan debt.
The good news is, there are a few things you can do to avoid this from happening. But before we get into those, let’s take a moment to review how financial aid is determined in the first place.
How Financial Aid Eligibility Is Determined
To apply for federal financial aid, students must fill out the Free Application for Federal Student Aid (FAFSA). To calculate how much financial assistance a student needs, the FAFSA uses a formula that takes into account various factors, including their family’s assets and prior tax year’s income.
The federal aid offered to your child will depend on the financial needs determined by the FAFSA.
How An Inheritance Can Affect Eligibility
As you can imagine, if you or your child receive a large inheritance, these increased assets can throw off the formula, making it appear like you need less government help to pay for tuition.
This mainly happens with large inheritances.
If the inheritance is smaller and doesn’t add a significant amount to your family’s total assets, it might not affect financial aid that much. This is because the FAFSA has what is called an asset protection allowance. Depending on the age of the parents, a certain amount of assets are hidden from the formula. However, once that asset allowance is passed, the formula kicks in and starts assuming more parental financial contribution. (1)
So, to make sure aid isn’t affected, the goal is to minimize assets as much as possible.
Strategies For Minimizing An Inheritance’s Effect On Aid
There are various strategies for minimizing the effect that an inheritance has on your child’s financial aid.
The first is pretty straightforward—use the inheritance to pay down debts. The FAFSA formula does not account for consumer debt like credit cards and auto loans. If you use your new funds to pay off debts, you’ll decrease your total assets and show the FAFSA formula that you require more financial assistance.
The second method is a bit more complex. Similar to how consumer debt is not included in FAFSA calculations, there are also several non-reportable asset classes that you can omit from your FAFSA. These include family homes, small businesses, qualified retirement plans, life insurance policies, and personal possessions (to name a few). (2)
By shifting the inheritance from a reportable asset to a non-reportable asset, you can minimize the effects it has on aid eligibility.
Before you make any financial moves that might affect your EFC, obviously the first step would be to calculate your family’s EFC as if your student would be going to college today. Then we would do an analysis of what your new EFC might be if the changes were made, and then see if that has any effect on the possible schools that could be on your student’s list. A change in your EFC might affect one school more than another.
If you’re worried about how an inheritance will affect your child’s financial aid opportunities, or any other assets, your best bet is to speak with a financial advisor. At SageView Advisory, we can help you create a plan to shield the inheritance from the FAFSA formula and maximize the aid they receive. To get started, email me today at dcoen@sageviewadvisory.com or call 800-814-8742.
About Dave
Dave Coen is a Financial Advisor with SageView Advisory and the CEO of College Planning America. Along with his retirement financial industry experience, he is a College Planning Specialist. He works closely with individuals and families to provide comprehensive financial planning that addresses all elements of their financial picture. Learn more by connecting with Dave on LinkedIn.
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(1) https://studentaid.gov/complete-aid-process/how-calculated#efc
(2) https://www.cappex.com/articles/money/how-to-shelter-assets-on-the-fafsa
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