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Cracking the Financial Aid Code
By Jeff Peller
College is expensive and these days, more and more students are qualifying for financial aid.
Yet many of our clients assume they won’t need, or even be eligible for, financial aid. Neither is
necessarily true.
Will You Be Eligible?
The chart below summarizes the key factors that will affect whether you’ll qualify for financial
aid. (All figures assume you have one student in school.)
Income and Asset Levels at Which Financial Aid Might Not Be Available
Family Income & Assets
Assessment
Rate
Public College
($20,000)
Private College
($40,000)
Parent’s Income
0% to 25%
$100,000
$175,000
Parent’s Non-Retirement Assets
5.6%
$350,000
$700,000
Student’s Assets
20% to 25%
$100,000
$200,000
Student’s Income
50%
$40,000
$80,000
A combination of the above variables determines what your family should contribute.
To enhance the amount of aid your child or grandchild might receive, consider the
following strategies:
• Save In the Right Name
• Save in the parent’s name, not the student’s. Student income and assets are
assessed at the highest rates.
• Convert current custodial accounts to custodial 529 accounts. The assets will be
considered a parental asset. Watch out for capital gains on the conversion if the
student is currently applying for aid.
• Grandparent’s ownership of 529s can affect aid. Qualified withdrawals are treated
as income to the student and assessed at 50%. Consider changing the owner of the
529 to the parent or student prior to starting college. There should be no gift tax
consequences.
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• Delay gifts to students until after graduation. A cash gift from anyone other than
a parent is reported as income (50%) for financial aid purposes. A third party
paying the school directly can reduce aid dollar for dollar as well.
• Trusts don’t help, they are considered a student’s assets if the student is
a beneficiary.
• Reduce or Reposition Assessable Assets
• Pay down debt. Financial aid offices only look at assets and income, not debt
and expenses, when determining aid. By paying down debt, you reduce
assessable assets.
• Make large planned purchases (cars, computers, furniture, etc.) the year before your
child begins college. Use custodial accounts and trust funds for these purposes as
well as for paying for private school before the student starts college.
• If assets are in a child’s name, consider using them to pay for the first year of
college. By reducing the child’s assets in the first year, you’ll likely increase your
chances of qualifying for more financial aid in subsequent years.
•
Time Income Correctly
• Income counts much more than assets under the financial aid formulas. When
possible, defer income.
• If possible, avoid capital gains during college years as these are considered income
for financial aid purposes.
• Maximize retirement plan contributions and minimize withdrawals. Retirement
account assets are excluded from assets but withdrawals are included in income. If
you must use these funds, borrow from your 401(k) instead of taking a distribution.
•
What Else Do You Need to Know?
• A college’s financial aid formula may be different from the federal government’s
formula and may not recognize a strategy that would work under the federal
methodology.
• The increased financial aid may consist entirely of loans that you or your child will
need to repay.
• It is generally not a good idea to drastically change your overall financial planning
scheme just for financial aid reasons. Ideally, any changes you make should fit with
your overall financial plan.
The Cost of College
According to the College Board’s “Trends in College Pricing,” in 2012-13, the average cost
of college was $17,860 for students attending four-year public colleges and universities and
$39,518 for students at four-year private colleges and universities. This includes tuition, room
and board, but does not include books, supplies, transportation and other expenses.
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At the University of Georgia, in-state undergraduates will pay $18,600 for tuition, room and
board. Sixty-one percent of undergraduates were offered aid and the average need-based
scholarship or grant award was $9,711. At Georgia Tech, in-state undergraduates will pay $22,134
for tuition, room and board. Sixty-six percent of undergraduates were offered aid and the
average need-based scholarship or grant award was $11,802. The financial aid distribution was
66% scholarships/grants and 34% loans/jobs at both schools.
Variables That Affect Financial Aid
When you apply for financial aid, your college’s financial aid office will determine your expected
family contribution (EFC). Your EFC is the amount your family is expected to pay towards
college. Cost-EFC=Potential Aid. For an overview of the process and a helpful calculator, see
“The Expected Family Contribution (EFC): FAQs.”
The formula for determining your EFC is complex, but the basics are this: The higher your
income, and the more assets you have, the more you’ll be expected to contribute. The four
primary factors are:
The Parent’s Adjusted Gross Income (0% to 25%)
This is the primary variable for most families. The chart below offers a rough guide,
based on income alone for a family with two dependents:
Parents’ AGI
EFC
%
$25,000
$0
0%
$50,000
$3,000
6%
$75,000
$9,000
12%
$100,000
$17,500
17%
$125,000
$24,500
20%
$150,000
$32,000
21%
$175,000
$40,000
23%
$200,000
$47,500
24%
Your EFC will be zero if your income is very low and up to 25% as your income increases.
For each additional dependent, the EFC is reduced by roughly $1,500.
As you can see, families with an AGI under $50,000 will not be expected to contribute a
lot and may be offered significant need-based aid. Most families with AGI in the $75,000
to $100,000 range can expect some aid. These are the families that can most benefit from
taking steps to arrange their finances in the most favorable way as the college
years approach.
Finally, please note that families with more than one student in school at the same time
will qualify for more aid. The parents’ expected contribution won’t increase and will be
split equally among the students in college. As a result, families with multiple children in
school simultaneously are some of the best candidates for aid.
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The Parents’ Non-Retirement Assets (5.6% above APA)
Parents are expected to contribute approximately 5.6% of their assets for college.
The EFC considers parent’s reportable assets above an asset protection allowance (APA)
based on the family size and age of the older parent (typically about $40,000–$50,000,
and excluding property such as cars, primary home, etc.). In calculating which assets to
report, please note the following:
• Taxable assets, including all bank accounts, taxable investments accounts, stocks,
bonds and real estate equity (but usually not your primary home) are included in
the calculation.
• Retirement assets [401(k), IRA, cash-value life insurance, annuities] are excluded
from assets but withdrawals are included in income. If you must use these funds,
borrow from your 401(k) rather than taking a distribution.
• Home equity is not considered by the federal government when calculating your
total assets. However, most colleges do consider home equity when determining aid.
• Outstanding debt is a factor in the federal government’s financial aid calculations.
Liabilities against reportable assets are considered; for example, a home mortgage is
deducted from the value of the primary residence to determine the current equity),
but other liabilities (credit card debt, medical bills, car payments) are not. If you have
other outstanding debt (credit cards, car loans, mortgages, etc.), pay it off before
filing your FAFSA.
The Student’s Total Income (50% above IPA)
A student is expected to contribute 50% of all income earned over the annual income
protection allowance (IPA). In 2013/2014, the first $6,130 of student income is excluded
when determining a child’s total income. In calculating the student’s income, please
note the following:
• Capital gains count as income. It is important to time capital gains appropriately as
the student approaches his or her college years.
• Untaxed income to the student is included. Qualified distributions from educational
savings accounts (529s and Coverdell) owned by a third party such as grandparents
will count as income to the student. See the section below for special rules on 529
plans and ways to avoid this.
The Student’s Assets (20% to 25%)
Student assets are assessed at a rate of approximately 20% for federal and 25% for
institutional analysis. This chart at FinAid.org, offers a useful summary of the financial aid
impact of various savings vehicles.
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• Trust funds are typically not an effective way to shelter money from financial aid,
since they are considered an asset up to the portion attributable to the student. The
same thing applies to parents. Even if access to the trust fund is restricted, it can
still be assessed when making a financial aid determination. If there is more than one
beneficiary, then the trust is divided equally for financial aid purposes.
529 Plans and Financial Aid Eligibility
Under the federal methodology, 529s owned by a parent are treated as a parent’s asset. There
are a few special rules to keep in mind about the classification of 529 plans for federal financial
aid purposes:
•
Any student-owned or UTMA/UGMA-owned 529 account is also considered a parental
asset and reported as such on the FAFSA if the student files the FAFSA as a dependent.
(A 529 account is considered an UTMA/UGMA-owned account when UTMA/UGMA
assets are transferred to a 529 account.) The same is true for Coverdell education
savings accounts.
• Planning tip: Convert custodial accounts to custodial 529 accounts. The assets will
be considered a parental asset at 5.6% vs. 20% for the child. Watch out for capital
gains on sale of custodial account.
•
Under the federal method, distributions (withdrawals) from a 529 plan that are used to
pay the beneficiary’s qualified education expenses aren’t classified as either parent or
student income on the FAFSA, so they don’t affect financial aid eligibility. The same is
true for Coverdell education savings accounts.
•
If a grandparent or other person is the account owner, then the 529 plan does not need
to be listed on the FAFSA so the asset is ignored. However, qualified distributions are
treated as untaxed income to the student beneficiary on the next year’s forms. Student
income reduces aid eligibility by 50%. This can be addressed in the following ways:
• Wait until the senior year (spring of junior year) to take distributions since that will
be after the calendar year on which the final FAFSA is based.
• Change the account owner to the parent or student. These will be considered assets
of the parents under the above rules and the qualified withdrawals won’t impact aid.
Changing the owner of the accounts should not create any gift tax implications.
• Wait until the student has graduated and take non-qualified distributions to perhaps
pay off debt. But don’t forget there is income tax and a 10% penalty on the earnings
that will need to be considered.
•
If a parent owns several 529 plan accounts for multiple children, they must list the value
of all of the accounts on the FAFSA.
•
If a parent’s adjusted gross income is less than $50,000 and a few other requirements
are met, the federal government doesn’t count any of that parent’s assets in determining
EFC. So, a 529 plan wouldn’t affect financial aid eligibility at all.
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•
The institutional methodology treats 529 plans as a parental asset. When funds are
withdrawn, the institutional methodology typically treats the entire amount (contributions
plus earnings) as student income.
Plan Ahead for Financial Aid
As you can see, navigating the financial aid maze can be complicated. The important thing to
remember is that you shouldn’t assume that your income automatically disqualifies your student
from receiving financial aid. Making some strategic planning decisions now regarding savings
and assets can help maximize the amount of aid you do qualify for when it’s time to send your
student off to college.
600 Peachtree Street, NE Suite 2700 Atlanta, GA 30308 404 253 7600 www.signaturefd.com
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