Grandparents Help

Accounts owned by grandparents are not included in initial financial aid calculations. Sounds like a good thing, right?

Except that any withdrawals count heavily against the grandchild in the next year's aid calculations. Distributions from grandparent-owned accounts are considered untaxed income to the student, which means he or she could lose a big chunk of grants or scholarships: up to half the amount distributed.

By contrast, accounts owned by parents or students are considered parental assets. That means up to 5.64 percent of the account balance is included in financial aid calculations, but distributions are not.

A few workarounds exist, such as transferring the account to a parent if the plan allows or waiting to withdraw the money until Jan. 1 of the student's junior year. At that point, any withdrawals will not affect aid eligibility, which is based on the previous year's financial details.

Another solution could be gifting any money withdrawn to the parents. The Internal Revenue Service has not specifically blessed the move, Hurley said, but he does not see much risk from it if the account beneficiary incurs sufficient qualified expenses.

The Divorce Trap

A similar problem awaits divorced parents. Financial aid calculations typically are based on the income and assets of the parent with whom the child lives most of the time.

Non-custodial parent accounts typically are excluded from the first financial aid calculations, but distributions count as the student's income in later aid determinations.

A non-custodial parent can try the same workarounds as grandparents but may be leery about handing money to the ex rather than to the student or the school.