College is one of the biggest investments that a family will make for its children. Four years of college can run upwards of a quarter of a million dollars at a private school and roughly half at a public institution. The reality is that two-thirds of families do not pay the full amount. They receive financial aid in the form of grants and scholarships. With some planning, more families can qualify or increase their financial aid package.
Most colleges determine eligibility for financial aid by estimating the Expected Family Contribution (EFC). Every year, families submit the Free Application for Federal Student Aid (FAFSA) form. FAFSA updates the school on the income and assets of students and their parents used to determine eligibility for need- and non-need based financial aid. Need-based aid is the difference between the Cost of Attendance (COA) for a particular school and a family’s EFC. Non-need based aid is the difference between COA and financial aid already awarded to the student. Students that do not expect to qualify for grants and scholarships should still consider filing FAFSA. First, they may be in for a pleasant surprise and qualify for aid. Second, schools use FAFSA to determine eligibility for some student loans.
Investing time to understand FAFSA can yield returns by helping a family reduce its EFC. Smart decisions can increase financial aid by reducing income or assets reported on FAFSA and a family’s EFC. FAFSA places more weight on income than assets. It may count up to 47% of parental adjusted annual income toward EFC. For assets, FAFSA counts 20% of student assets and 5.64% of parental assets. See www.studentaid.gov from the U.S. Department of Education for more details.
Timing matters
Families should consider how the timing of when they take income could affect financial aid. Parental income counts 8x more than assets in the EFC formula. Parents can reduce the income reported on FAFSA, for example, by choosing to delay or advance the time they realize capital gains or take a bonus.
FAFSA has a new look back policy for income. Starting with the 2017-2018 school year, FAFSA will implement a new two-year look back rule. Before, it used a one-year look back to determine the current year’s financial aid eligibility. The change means that 2015 income used for the calculations for the 2016-2017 school year will also apply for 2017-2018. Figures for 2016 income will apply for the 2018-2019 school year. In other words, this year’s income will not affect financial aid until the school year starting in fall 2018. Families, especially those with students starting or finishing school in the 2018-2019 school year, should plan accordingly.
Ownership matters
When it comes to assets, who owns the account can affect EFC and eligibility for aid. The treatment for parental assets is more favorable than student assets. FAFSA counts 5.64% of parental assets toward EFC for a dependent student. It counts 20% for a student’s assets. Assets owned outside of the immediate family can have a more favorable 0% weight. At present, FAFSA does not ask about assets not owned by the dependent student or the parents. In contrast, a student’s UTMA or UGMA custodial accounts have the higher 20% weight. For the purpose of financial aid, FAFSA considers the student to be the owner of the UTMA/UGMA.
In a previous article, I wrote about the benefits of 529 accounts as a way to save for college. If used for higher education as intended, earnings in 529 accounts are not subject to tax. This would leave more to pay for school. Disbursements will not count hurt a student’s financial aid eligibility the next school year if the FAFSA form included the 529 account balance. They can hurt eligibility if funds came from a 529 account that was not included on the FAFSA. Such funds would count as a student’s untaxed income.
Prioritizing which accounts to tap first can greatly affect financial aid. A bad choice can increase income on next year’s FAFSA. Imagine if grandpa paid for freshman year with a $50,000 disbursement from the 529 he owned instead of mom paying using money from her 529. The money from grandpa would count as income for the next year because grandpa’s 529 was not reported on the FAFSA for freshman year. FAFSA counts 50% of the income towards EFC, effectively increasing EFC and reducing aid eligibility by $25,000 for sophomore year. Had mom paid for freshman year using her 529 account, which should have been reported on FAFSA, there would not have been a reduction in eligibility for aid.
Location matters
FAFSA does not treat all assets equally. Asset location can affect EFC. Two families with the same amount of assets and income can have very different EFCs. Imagine if one kept its assets in cash, checking, brokerage and 529 accounts while the other kept its assets in its home and retirement accounts. The first family would have much higher EFC and less eligibility for financial aid. The EFC calculation includes more of its assets. The second family would have much less assets because FAFSA excludes the value of a primary residence and retirement accounts. FAFSA also excludes the value of life insurance policies and tax-deferred annuities. Other exclusions include the value of a small family-owned business and some rental property. Check with the Department of Education and the school for the fine points for what counts and what does not. A family can be strategic about how to position its assets to increase eligibility for aid.
Not all schools use the FAFSA to determine eligibility for financial aid. About 300 schools, including many of the top private and some public institutions, use the CSS/Financial Aid PROFILE form. The CSS/Financial Aid PROFILE form uses a different methodology to calculate EFC. They differ in their treatment of the value of a primary residence, accounts not held by parents or students, the weight on student assets and many others. Schools may also use their own formulae to calculate EFC.
Recently, a family that I know received different EFC estimates from two Ivy League schools. The difference was significant. One school offered much more grant aid, increasing its affordability. It turns out that the schools used different forms and methodologies to calculate EFC. The family informed the less generous school of the discrepancy. At the end, the less generous school adjusted its EFC estimate and increased its grant offer to make the actual cost to the family competitive.
