Effect on Financial Aid Package if Parents Inherited IRA

The time before you head off to college represents is a new beginning and a time when you start to really consider your future. One specific part of that future is how you are going to afford the hefty price tag that accompanies a college education. Financial aid is available to help students and parents ensure that you are not left without the option of attending a college or university. However, you need to understand what affects the reception of financial aid and your estimated family contribution towards your education.

Financial Aid Eligibility

Financial aid eligibility depends on your cost of attendance less your estimated family contribution. Cost of attendance includes the estimated expenses for tuition, room and board, books and supplies and personal expenses, including transportation and dependent care. This value rises depending on the institution you selected. It is important to understand that affording college requires much more than just affording the tuition payments. This may affect how much you think you need to borrow from the government or a lending institution, such as a bank.

Estimated Family Contribution, or EFC

Your EFC is a component of a portion of your family's assets and income. The amount of income that your family receives is dependent upon the value of the total assets that your family owns. An inherited IRA causes the dollar value of your family's total assets to increase, meaning that your family will reasonably be expected to afford a greater amount of your college education expenses. Your assets and income are also considered in determining your EFC.

Effects of Increase in Assets

When the assets of your family increase, which generally happens when they inherit any portion of an estate such as an IRA, the government expects your family to pay for a greater amount of your collegiate education up front. It simply increases the amount you are expected to pay, but does not eliminate the possibility of receiving financial aid completely in most cases. Therefore, the effects of the inherited IRA depend on the worth of the entire account. If your family's assets are under $50,000 and this account does not push them over this mark, the effects are negligible. However, if it increases the value of their total assets above $50,000 or $100,000, then the effects are somewhat greater.

Effects of Required Minimum Distributions

If your parents inherit a traditional IRA from a family member, they will be required to take required minimum distributions each year. This will increase their income, but by how much depends on the full value of the account and the actual beneficiary's age. A required minimum distribution is an amount that the IRS requires a person to take out of a traditional IRA each year. It does not affect Roth IRAs as there is no required minimum distribution for this type of account. Using the single life expectancy table that the IRS provides, the parent that is the beneficiary on the account must determine his or her life expectancy and divide the account balance by that number each year. For example, if your 52 year-old father is the beneficiary and there is $100,000 in the IRA, he is required to withdraw $3,095.98 in the first year following the owner's death.

Using Money to Pay For Education

It may be beneficial to consider using the required minimum distributions that your parents must withdraw from the IRA to help fund your educational expenses. This can help compensate for any financial aid reduction that you experience because of the inheritance. The IRS encourages the pursuit of college education and therefore provides a tax deduction of up $4,000 for any tuition or fees paid out of pocket. This can help to offset the extra income taxes that your parents will incur because of the increase in income from the required minimum distribution.