If you’ve received an inheritance or expect to receive one in the future, you probably have a lot of questions about the money you’ve inherited, including how you can use it to help pay for college and whether it will impact college financial aid.
In this article, we’ll answer some of the most common questions that people have about an inheritance and college financial aid. We’ll also take a look at whether you should use your inherited money to help pay for college and what mistakes you should avoid.
Knowing how it works, planning ahead as soon as possible, and making the right moves are all critical to making the most of your inheritance when it comes to college, so let’s jump in and start answering the key questions.
Do I have to report an inheritance on the FAFSA?
Generally, an inheritance doesn’t need to be reported as income on the FAFSA, but you have to report inherited financial assets on the FAFSA if the following three conditions are all true:
- The transfer of your inherited assets has been completed.
- The assets are now owned by the student or one of a student’s parents.
- The assets you inherited are any of the following:
- Cash
- Bank accounts such as savings, checking accounts and CDs
- Investments such as stocks, bonds, mutual funds and ETFs
- 529 or Coverdale college savings plans
- Any real estate that isn’t your primary residence
- The value of a small business, company or partnership that you own
- Exotic investments such as cryptocurrency, coins, stock options or futures
- Collections such as fine art, automobiles, or other valuables
You do not have to report the value of inherited retirement accounts such as 401Ks, 403Bs, IRAs, Roth IRAs, and annuities, but any withdrawals from these accounts may generate income that you must report on your FAFSA.
Hence, it’s extremely important to take an inventory of what you’ve inherited, assess whether it can potentially impact college financial aid, and start planning your best financial moves as quickly as possible.
To learn more, check out my article on the 8 Types of Inherited Assets and How They Impact College Financial Aid, or watch the video version below:
What types of inherited assets are not reported on the FAFSA?
The following types of inherited assets are not reported on the FAFSA, but withdrawals from these assets may generate taxable income that you must report on your application:
- Retirement assets such as 401Ks, 403Bs, pensions and other work retirement plans
- IRAs and Roth IRAs
- Annuities
Additionally, you do not need to report any inherited real estate that is your primary residence.
You also do not have to report an expected future inheritance or any other inheritance that hasn’t been completely transferred. Any inherited asset that is still in process, stuck in probate, or has other issues that prevent a complete transfer do not need to be reported.
Thus, it might make sense to speed up or slow down the inheritance process, to time it with the tax years that will be used for your FAFSA application.
Does an inherited trust impact college financial aid?
Yes, if the inheritance is in a trust, the value must still be reported if the student or a parent is a beneficiary of that trust in any way. If the student or parent is a beneficiary of a trust, then it can potentially reduce or eliminate your college financial aid eligibility. Generally, using a trust is not an effective way to prevent an inheritance from impacting college financial aid.
Will my inheritance reduce my college financial aid eligibility?
In most cases, an inheritance will potentially reduce your college financial aid eligibility and award, especially if you have inherited assets whose value must be reported on the FAFSA or if you must make required withdrawals from your assets that need to be reported on the FAFSA as income. If any of your inherited assets generate income in any other way, then you may need to report that as well.
The good news is that you can potentially reduce or eliminate the negative impact of an inheritance on college financial aid by planning and making the right moves with your money, as early as possible.
If you time your withdrawals from your inheritance properly, or if you move or reinvest the money into assets or investments that are excluded from financial aid consideration, then you can potentially exclude some or all of your inheritance from the college financial aid process. The college financial aid rules allow for this, so it’s best to understand and take full advantage of these opportunities.
Also, keep in mind that assets inherited in the student’s name have more of a negative impact on college financial aid than assets that are inherited in a parent’s name. This is because a larger percentage of a student’s financial assets are assumed to be available to help pay for college than a parent’s assets. Thus, if you have options to move assets from a student’s name to a parent’s name, or if you can transfer them to the name of another trusted family member, then this may be a smart move to consider as well.
To learn more the best options to manage your inheritance and minimize any negative impact on college financial aid, read my article on the 8 Types of Inherited Assets and How They Impact College Financial Aid.
However, not everyone who receives an inheritance will lose some or all of their need-based college financial aid eligibility. Let’s take a look at two cases where this might happen:
- If your inherited assets are of a type that don’t have to reported on the FAFSA (see the first question section above), then they will not have any impact on your aid eligibility or award.
- If you already earn too much income and have too many financial assets to be eligible for need-based college financial aid, then your inheritance won’t have any impact at all. But never assume that you won’t qualify for financial aid.
Many families assume that they won’t qualify for need-based aid, but the reality is that many colleges offer aid to families, even if those families have relatively high incomes and financial profiles. This is because college is expensive, and most schools have to offer aid in order to attract students and make the costs more affordable.
An inheritance might undermine some of your aid eligibility at some colleges, so you should always estimate your college financial aid eligibility based on your current income and assets, and then review your inherited assets to see how they might impact that estimate.
To learn more about specific types of inherited assets, whether they impact college financial aid, and how to plan accordingly, check out my detailed article on the 8 Types of Inherited Assets and How They Impact College Financial Aid.
How can I protect my inheritance from the FAFSA and maximize financial aid?
Only your income and certain types of financial assets must be reported on the FAFSA. So, it’s possible to manage your inheritance in ways that minimize or avoid generating income or move your money into types of assets that don’t need to be reported on the FAFSA and don’t have any negative impact on college financial aid eligibility.
For example, if you’ve inherited retirement accounts such as 401Ks, 403Bs, pensions, IRAs, Roth IRAs, and annuities, you don’t have to report the value of these accounts on the FAFSA. So, you can roll them over into a beneficiary retirement account, and, even though financial regulations require that you start making withdrawals from these accounts, typically over the next 10 years, you can time those withdrawals and structure them so they generate as little income as possible during the years when you have to report your income on the FAFSA.
Similarly, if you’ve inherited cash or a checking account, where you’d normally have to report this money on the FAFSA, you can potentially move and invest that money in a retirement account, where you wouldn’t have to report the value of your money for college financial aid purposes.
You can also use some of your inheritance to pay off debt or otherwise make financial moves that improve your overall financial situation while minimizing the income and financial assets you have to report on the FAFSA, and thus maximize your eligibility for financial aid.
These are only a few examples of the many ways you can plan, manage and work with your inheritance to protect your money from the FAFSA and potentially increase your college financial aid eligibility. For more on strategies to help you do this, check out my article on the 8 Types of Inherited Assets and How They Impact College Financial Aid.
Should I use an inheritance to pay for college?
In many cases, it might make sense to use some or all of an inheritance to help you pay for college, but sometimes it’s much better to use other assets to pay for college while you maximize the financial benefits of your inheritance in other ways.
For example, if you inherited an IRA and are paying $50,000 per year in college expenses, and you plan to withdraw $50,000 from the IRA to pay for college for the current year, it might cost you around $15,000 to $20,000 in need-based college financial aid, plus an additional $7,500 to $15,000 in taxes, depending on your tax bracket. So, the $50,000 that you withdrew might only create a net financial benefit of $15,000 for you, after your losses in financial aid and taxes.
So, instead of withdrawing from your IRA, you might be able to use your cash savings, monthly cashflow, other retirement assets, or low-cost student loans to help you pay for college without incurring huge financial aid losses or tax bills. That way, you can potentially maximize the full financial benefit of your inheritance and all of your available income and assets, by being as smart as possible with your money.
To do this, you need a long-term plan for how to manage your inheritance and how to manage all of your other money, assets, savings and investments, so you can make the right moves and make the most of your money while minimizing taxes and maximizing your opportunities to receive college financial aid.
If you’re not already working with a Certified Financial Planner® and college funding specialist who can help you do this, then you should reach out to an expert as soon as possible, to review the assets you’ve inherited, identify your best options, and start building a good financial plan.
As a CFP who specializes in inheritance, college, retirement, and overall financial planning, I can help you get started. For more than 20 years, I’ve helped hundreds of parents, students and families plan, save, and invest for their financial future. I’d be happy to set up a free consultation to review your situation and provide expert guidance, or you contact me at 414-420-4200 or via email with any questions.
Disclosures
Always remember that investments, assets and how you manage them involve risk. Please carefully consider your investments and assets and any risks, charges and expenses.
In addition to working with a Certified Financial Planner® to help manage your assets appropriately, it’s also a good idea to consult a tax professional, to make sure you understand the state and federal tax rules around how you make withdrawals on inherited assets and how you manage them.
Brad Baldridge is a Registered Representative, Securities offered through Cambridge Investment Research, Inc. a Broker/Dealer, Member FINRA / SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Fixed insurance services offered through Baldridge Wealth Management. Cambridge’s Form CRS (Customer Relationship Summary). Taming the High Cost of College, Baldridge College Solutions, and Cambridge are not affiliated. Cambridge does not provide tax or legal advice.
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