Students who plan to seek financial aid start the process by completing the Free Application for Federal Student Aid. The FAFSA uses a variety of formulas to determine the financial need for a potential student, including looking at the family finances and the prior tax year's income. An inheritance or gifted money can affect how much aid a student is eligible to receive.
Inheritance as Income
The usual treatment of one-time events, such as receiving an inheritance, is to make an adjustment to the family's income while still assessing the money as an asset, according to the website FinAid. Inheritances show up as untaxed income on Worksheet B of a 1040 filing. A financial aid administrator has discretion about how to treat the inheritance by using professional judgment, so some of these administrators may eliminate gifts or inheritance from income.
Asset Protection Allowance
FAFSA allows a certain amount of assets to be shielded from assessment, based on the age of the older parent. According to the website FastWeb, most parents of college-age children have an allowance of about $50,000. This means an inheritance that does not increase the parent's assets so that his assets equal more than $50,000 will not affect a student's financial aid.
Expected Family Contribution
Financial aid administrators use a needs analysis formula, and this formula takes into account the expected family contribution. The formula uses a bracketed system with a top bracket of 5.64 percent for any assets above the $50,000 threshold. So if the assets are $100,000, then $50,000 of the assets would be above the threshold and subject to the 5.64 percent reduction of $2,820. Additionally, families can document a special circumstance that affects their ability to pay the expected family contribution so that families can renegotiate their child's financial aid package by decreasing their expected family contribution.
Decreasing the Inheritance
It may be possible to lower the amount of inheritance to decrease the amount of assets a family has to record on the FAFSA. For example, if the student's parent received the inheritance, he may pay off credit card debt and auto loans because the federal needs analysis formula does not take consumer debt into account.
A family may structure gifts or inheritances in a way to minimize the effect on the student's financial aid. For example, an ailing relative may put the expected funds in a trust to be disbursed at a lower rate while the student will likely be in college. Because the FAFSA considers the prior year's tax return, a gift can be given the year before that time or in the student's final year of college.
Samantha Kemp is a lawyer for a general practice firm. She has been writing professionally since 2009. Her articles focus on legal issues, personal finance, business and education. Kemp acquired her JD from the University of Arkansas School of Law. She also has degrees in economics and business and teaching.