Pinnacle Estate Planning

By JASON GRAY

Pinnacle Law PLLC

    For families planning for the future, understanding how an inheritance could affect a student’s financial aid eligibility is crucial. The Free Application for Federal Student Aid (FAFSA) uses a formula that considers both the student’s and parents’ income and assets to determine financial need.  Receiving an inheritance—whether during the college years or before enrollment—can significantly alter a student’s aid package. However, with proper planning, the impact of an inheritance on financial aid can be minimized.

How an Inheritance Affects Financial Aid

    FAFSA evaluates financial information from the “prior-prior” tax year. For example, a student applying for the 2025-2026 school year will report income and assets from 2023. If an inheritance is received during the assessed period, it could increase reported income or assets, depending on how the funds are handled. This, in turn, may reduce the amount of need-based aid the student qualifies for.

Income Impact

    Inheritance received as a lump sum could count as income on FAFSA. For dependent students, 50% of their income above a small income protection allowance is considered available to pay for college, significantly reducing financial aid eligibility.

Asset Impact

    If the inheritance is converted into assets such as savings accounts, stocks, or real estate, it may still affect aid eligibility. FAFSA assesses parent assets at a rate of up to 5.64%, and student assets at 20%, potentially lowering aid eligibility further.

Steps to Minimize Financial Aid Impact

    To mitigate the effect of an inheritance on financial aid, consider these strategies:

1. Use a Trust for Inheritance Planning

    Setting up a properly structured trust can shield inheritance assets from being counted on the FAFSA. Trusts like irrevocable trusts are excluded from FAFSA’s asset calculation if the student does not have direct access to the funds. Be cautious, though—income distributions from the trust could still count as income.

2. Delay the Inheritance

    If possible, timing the receipt of the inheritance to fall outside of the FAFSA reporting years can help. For example, distributing funds after the student graduates could ensure the inheritance doesn’t impact aid eligibility.

3. Spend the Inheritance Strategically

    Inheritance used for non-reportable assets, such as paying down debt, purchasing a primary residence, or covering education expenses, won’t affect FAFSA calculations. This approach can reduce the funds available for assessment while serving long-term financial goals.

4. Use 529 Plans Wisely

    Inheritance funds placed in a 529 college savings plan owned by a parent are treated more favorably by FAFSA than student-owned accounts. These accounts are considered parental assets, assessed at a lower rate of 5.64%, compared to student assets.

5. Consider Professional Advice

    Working with a financial advisor and an estate planning attorney can help families navigate the complexities of inheritance and financial aid. Professionals can recommend tailored solutions, such as specific types of trusts or strategic timing for inheritance distributions.

Conclusion

    Receiving an inheritance can be a blessing, but without careful planning, it may unintentionally reduce the financial aid a student is eligible for. By understanding FAFSA’s rules and exploring strategies like trusts, timing distributions, and strategic spending, families can protect both their inheritance and the student’s aid eligibility. Proper planning not only ensures that financial aid is maximized but also helps safeguard the inheritance for its intended purpose—building a secure future for the next generation.

*This article is for informational purposes only and should not be construed as legal or financial advice.