A family’s budget for college education will easily be one of the most expensive purchases ever. The current average cost at a public four-year college is $7,605 per year in tuition and fees for in-state students. It is no wonder that during the 2008-2009 school year, more than 78% of undergraduate students received some form of financial aid.
A financial aid package comes from multiple sources, including state, federal and institutional. Aid can be grants, scholarships or loans. Financial aid is intended to help you fill the gap between your ability to pay, which is called your Expected Family Contribution (EFC) and the Cost of Attendance (COA), which is the actual college costs. Financial aid is based on your financial need, which is the difference between COA and EFC. Eligibility for financial aid is calculated using a formula called Federal Methodology. It is based on the information that you provide on the Free Application for Federal Student Aid (FAFSA).
To enhance your child’s financial aid eligibility is to lower your expected family contribution. These strategies are perfectly legal and are not designed to undercut the federal financial aid process. Families simply need to understand which assets and income are used to determine a student’s financial aid eligibility. Some will believe this is advising rich people to look poor, but that is not the intent. Additionally, there is no guarantee that an increased aid package will consist of scholarships and grants. Your student’s financial aid package may be entirely loans, which, while at very favorable rates, still have to be repaid.
Unfortunately, need analysis formulas often do not accurately reflect a family’s ability to pay. For example, the federal methodology ignores consumer debt; thus, some families look more affluent than they really are.
Certain strategies that you employ may put you in a better financial position. For example, home equity is not counted as an asset, so you might consider paying down your mortgage sooner. You could likely benefit by saving on mortgage interest and owning your home sooner. However, this particular strategy generally applies to federal methodology. Most colleges consider home equity in determining a family’s ability to contribute to college costs, because colleges do not use the same formula as the federal government.
Be Aware of the Student Income Limit
The federal government expects your child to contribute 50% of all earned income (after taxes) over the student income protection allowance. For the 2010-2011 academic year, students can earn up to $4,500 before their income is considered in determining financial aid eligibility.
Also, you should be aware that while 529 college savings plans owned by a grandparent are not included as assets on the FAFSA, the distributions from such a plan are reported as untaxed income to the beneficiary on the FAFSA.
Strategies to Reduce Available Income
The lower your adjusted gross income, the less money you will be expected to contribute toward college costs. Your income in the base year—the year before you complete the Free Application for Federal Student Aid—will directly affect your child’s financial aid eligibility in the following year. While you likely will not be able to defer your paycheck, you may be able to defer discretionary income, such as, bonuses, capital gains, IRA distributions, etc.
If you were to apply for financial aid in January 2012, you may want to consider:
- Deferring an employment bonus until after December 31, 2011;
- Avoid selling investments like stocks, bonds or mutual funds that incur taxable capital gains until after December 31, 2011;
- Selling investments that can be taken at a loss during the base year, as long as the investments are not expected to recover, and
- Avoiding pension plan and IRA distributions in the base year.
Strategies to Reduce Available Assets
The federal government includes some assets and excludes others in arriving at your family’s total assets. The lower your family’s total assets, the less money you will be expected to contribute toward college costs. When employing these strategies, choose the date you submit the FAFSA carefully. Assets are specified as of the application date.
Use Cash to Pay Down Consumer Debt
As stated before, the federal methodology does not account for the amount of consumer debt you may have. If you have $10,000 in cash and $10,000 in consumer debt, the federal government still lists your total assets as $10,000. If you use your available cash to pay down consumer debt, you may reduce the amount of your assessable assets.
Use Cash to Make Large Purchases
If you have large purchases planned, such as, a car, furniture or computer, consider making them with available cash in the year before your child begins college.
Pay Taxes Due
You may also consider paying all federal and state income taxes that are due during the base year. You can deduct the total amount of federal and state taxes you pay during the base year on the FAFSA. Additionally, this can reduce the amount of available cash on hand.
Leverage Parents’ Asset Protection Allowance
Under the federal methodology, parents are expected to contribute a maximum of 5.6% of their assets; however, parents are granted an asset protection allowance, which enables them to exclude a certain portion of their assets from consideration. Generally, the amount sheltered from the need analysis process is determined by the age of the older parent, when the child applies for financial aid. Basically, more assets are protected the closer a parent is to retirement. For example, for married parents where the older parent is 45 years old, the asset protection allowance is around $43,000. In comparison, the allowance if the older parent is 60 would be $64,000. In addition, money in qualified retirement plans, such as an IRA or 401(k), is disregarded by the need analysis formulas.
Once you determine what your asset protection allowance will be, any savings above this amount can be shifted to assets that are excluded by the federal methodology, such as, home equity, retirement plans, cash value life insurance, and annuities.
Use Student’s Assets for the First Year
The government expects a child to contribute 20% of his or her assets each year to college costs. Money saved in your child’s name is legally the property of your child. He or she could spend it on whatever they want when they reach the age of majority. Even if the parents set up a trust to restrict the use of the money to educational expenses, it can negatively impact financial aid eligibility, since the full value of the trust is counted as the child’s assets each year.
This is why it is important to note how families save money for college when deciding between 529 Plans, Education Savings Accounts or custodial accounts. Generally speaking, if the account owner has the ability to change the beneficiary at any time, the savings are treated as an asset of the account owner, not the beneficiary.
If assets have been accumulated in a child’s name, you may want to consider using these assets to pay for the first year of college. By reducing your child’s assets in the first year, you will likely increase your child’s chances to qualify for more financial aid in later years.
Bottom Line
At Henssler Financial, we believe you should Live Ready, and that includes using your savings wisely. Generally, we do not suggest that it is a good idea to drastically change your overall financial plan to enhance your child’s financial aid eligibility. If you get Federal student aid based on incorrect information, you are required to repay it. You may incur additional fines and fees. If you were to purposely give false or misleading information on your application, you may be fined $20,000, sent to prison, or both. Every school verifies the FAFSAs of at least one-third of their students, and some schools verify 100% of the financial aid applications.
We feel any changes you make should be in line with your overall plan. If you would like to talk with one of our financial planning experts, call us at 770-429-9166 or e-mail at experts@henssler.com.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
