<p>Someone approached me with the following question and I would like to give them some guidance: an 18 year old Freshman at a prestigious university just received a significant death benefit from the passing of a parent. The student is the sole beneficiary and there was no will designating the money to go into a trust. </p>
<p>The family is concerned that if the son receives this money it will jeopardize his scholarship. If anyone has been exposed to this situation, please advise. </p>
<p>I am guessing when completing future financial aid requests the student and family would be obligated to disclose this. </p>
<p>I think you are absolutely right if it is need based aid. Perhaps some more experienced people can discuss ways to invest the funds immediately so they don’t make such a big impact on the scholarship.</p>
<p>If the scholarship is need based, the inheritance will impact it. There are ways to mitigate the impact or eliminate it all together, BUT there are always downsides to those solutions.</p>
<p>Is the student at a Profile school or a FAFSA school? Did the student have to fill out a CSS Profile for financial aid consideration?</p>
<p>If the student has a large inheritance and can now pay on his own, why should he be allowed keep need based aid? If it’s merit aid,then he wouldn’t lose it.</p>
<p>It doesn’t sound like it’s a question of “if” the son receives the money if he’s the sole beneficiary. If the inheritance isn’t in the form of a living trust or life insurance, depending on the state it will most likely need to go through probate and will be hit with an inheritance tax. In some states this is very expensive. But assuming he’s lucky and there’s still a significant amount left, he can invest the entire amount into a 529 account. 529 accounts receive favorable treatment in the FAFSA calculation at least; for CSS Profile the answer is less clear and depends on the college.</p>
<p>There’s a downside to 529s, and that is that any gains not used for qualified education expenses will be hit with a 10% penalty plus income tax. This might not be such a problem though, because first there has to be a gain. Let’s assume there’s $100,000 in the 529, that nothing is withdrawn, and that after 5 years the gain is $20,000. The penalty would be $2000, and the income tax on the gain of $20,000 might be another $2000. So the realized gain, all other things being equal, would be $16,000; the student has $116,000 when he graduates from college. If the student draws down the money over the course of his college years (and why wouldn’t he? this would seem to be an excellent use of an inheritance) then the penalty wouldn’t come into play.</p>
<p>Obviously if you’re talking about an inheritance that’s a factor of 10 or more of the example above, the student would do well to seek the advice of a financial planner.</p>
<p>Assuming you’re talking about need-based aid, not merit. One significant issue is whether the college will treat the money as current income, or merely as an asset. For Profile schools, that makes a difference in the rate at which the FA office will expect him to draw from the amount inherited. If it’s the student’s own asset, the rate is higher than if the asset were in the name of a parent. Whether it’s an asset or income has been discussed here a few times, with no resolution that I could discern.</p>
<p>If the money is in the form of an IRA or another retirement vehicle, the student may be able to convert it to a “Beneficiary IRA” or “Inherited IRA”. This should cause it to be treated as a retirement fund (and invisible to FAFSA). The required annual withdrawals from the IRA are based on the beneficiary’s age, and could be small enough so as to have little impact on the student’s annual income. Remember that there are required minimum withdrawals from IRAs, but no limit as to a maximum withdrawal. The bulk of the money could be tapped at any time. Certain annuities operate in pretty much the same way. Sometimes a life insurance benefit can be converted directly into a new single premium policy which would effectively tie it up until needed.</p>
<p>Depending on how long the estate takes to clear, it could be more than a year before the student has access to the funds. Conceivably the money could be left in the estate until the kid graduates provided the executor is OK with that. It was more than two years before my mom’s estate was cleared, and I got the impression that that was a pretty average length of time. A complex estate or one with a slow-moving executor can take just about forever.</p>
<p>Has he in fact actually received the money already (cashed the check)? If not, there is not a problem right now. It becomes a problem for the FAFSA/CSS Profile year dealing with that tax return.</p>
<p>In the event that the benefit has NOT been paid, it might be beneficial for the executor of the estate to file a request with the insurance company to hold up payment until certain issues of the estate are examined (sound mind when naming beneficiary would be one issue). There may or may not be any real issues, but insurance companies are not generally in a hurry to pay out money, especially when the estate is questioning them.</p>
<p>In the end though this is a situation where inadequate estate planning on the part of the parents (and attorney) may end up costing them in their intent. Probably should have set up the estate to take the proceeds of the policy and build a 529 and/or IRA accounts (as income allows) for the student, minimizing the impact of the inheritance on FA formulas.</p>
<p>But remember that IRAs have maximum annual contributions. The maximum contribution for an IRA is $5000 (or up to the income earned if it is less than $5000).</p>
<p>
True if the student is still a dependent for FA purposes. Is the student still a dependent for financial aid purposes? That is does he still have a living custodial parent? For dependent students the favorable treatment of 529 accounts is that they are reported on FAFSA as parent assets so get more favorable treatment (5.6% of unprotected parent assets go to the EFC rather than 20% of students). If the student does not have a living parent and is now independent for FA purposes then 529 account funds would be treated the same as any other assets by FAFSA.</p>
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This would of have made any difference. Trusts are reportable assets for FA purposes and are not protected assets.</p>
<p>Yes he is obligated to report the inheritance once it has been paid to him (whether or not he has cashed the check I would think?) On FAFSA it may have to be reported as both income and as an asset. This is something that may be possible to get an adjustment for so that it is only either income or an asset. I believe the usual treatment is to include it as an asset and exclude it from income, but this is at the discretion of the FA officer (both how to and if to make any adjustment).</p>
<p>Good catch on the 529 being handled differently if he has no remaining parents (which we don’t have the answer to right now).</p>
<p>I talk about cashing the check more of as a figurative event (has the insurance company actually processed?) as opposed to just holding the check. Just because you’ve filed, doesn’t mean the insurance company has to pay promptly. And in fact if there is another heir (spouse or sibling) who may not feel that the insurance policy fits within the state laws for inheritance(equity requirements), they have every right to challenge the payment of the policy, which would result in the insurance company holding the check (even if it is in the posession of the son). In this case, the son has no asset nor income to report.</p>
<p>Another thought on the subject would be for the son to buy a primary residence with the proceeds from the policy. Won’t get past the income issue, but will deal with the asset issue (at least as far as FAFSA is concerned) and will cut down on his COA. Might even get a first-time-homebuyer’s tax credit to offset some of that loss of FA.</p>
<p>A Beneficiary IRA doesn’t have a maximum annual contribution because it is a conversion of the original IRA into an IRA in the name of the deceased paying out to the living person. Messy and complicated and clearly only for the brave/desperate/extremely well-organized to set up. I think there is a time limit in which this conversion has to be done. Ultimately I took the cash because it was just plain easier. For someone who needs to tie up money, it may be a viable option.</p>
<p>In my family’s case, the money could be left with the insurance company (I think it was in some kind of annuity, but I’ve forgotten the horrible details) for up to five years without being claimed. We also could take it at once or in installments. I spent about a year tracking down the Beneficiary IRA info. before cashing out. Two of my sisters took the money right away. My other sister waited until the insurance company wouldn’t keep it any more. She just plain didn’t know what to do with it and so she left it with them as long as she could.</p>
<p>All 529s are treated the same by FAFSA, both parent-owned and student-owned. Since the student’s parents are deceased, he would file as an independent. Even independent students can own and benefit from 529s.</p>
<p>^^^^ Sorry happymom, I should have been clearer, I was referring to putting the inheritance money in an IRA, not to beneficiary IRAs. As an aside this thread made me start thinking I need to read up on those so that if we have any $$s left in ours when we die (hopefully not for a while yet) I can leave the kids info on how to handle them. Though we have more in a company 401k than an IRA and this thread has made me realize I am not sure how those monies would be handled on our deaths - as in would they have to be cashed out or could the kids keep them in there or convert to beneficiary IRAs.</p>
<p>There really is not enough information for us to give anything but vague advice to the OP.</p>
Not true. All 529 accounts are not treated the same by FAFSA. They are all treated the same for dependent students. Not for independent students. There is no financial aid benefit or break for an independent student in having the money in a 529 account rather than in the bank or in stocks. They are not protected assets (like IRAs) and are reported and treated exactly the same as any other asset. (there is not even a place on FAFSA to report 529 accounts separately from other assets). If the student in independent then 20% of the 529 account will go to his EFC, exactly the same as if the money was sitting in the bank or a stock account. </p>
<p>The only special treatment 529 accounts get is that for dependent students, student owned 529 accounts are reported as parent assets. This means they are assessed at parent asset rates of up to 5.6% rather than student asset rates of 20%. An independent student cannot report a 529 account they own as a parent asset and must report them as part of their own assets.</p>
<p>A moot point if the student still has a living parent.</p>
<p>Going OT, but some personal advice from someone who has a beneficiary IRA…</p>
<p>There are 3 ways for how they are handled, you can either take the balance as a lump sum (taxable in the first year unless it is a Roth) within the first 5 years equally distributed, or over the lifetime of the beneficiary based upon the age rules for any other IRA (start small but each year a higher percentage of the remainder). I believe under this last scenario, you can sack the thing at age 59 1/2 regardless, but don’t quote me on this.</p>
<p>I am taking the latter of the 3 with a negligible payout every year. Since I take it in December, I look at it as buying holiday gifts.</p>
<p>Given a choice, I think the best scenario is to convert all of your IRA’s to Roth’s before you die, so the amount is smaller of an impact on FA all around, as I believe untaxed income is treated the same as taxed income for purposes of calculating EFC. And with the market down (it used to be more down) it makes entire sense to convert now (if you are not dealing with FA and can afford it) so the future growth (the market will comeback in 10 or so years) is not taxed.</p>
<p>Plus there is nothing worse than leaving your children a tax bill in addition to their inheritance.</p>
<p>^ Ah, I see you’re correct that all independent students’ assets are fair game and are assessed at 20%, with no asset protection allowance for anyone age 18. I stand corrected! No point in rolling anything into a 529 other than the possible tax benefits.</p>