Financial Aid for College: Positioning Yourself to Maximize the Benefits
By Katie Bruno, MIMFA
CERTIFIED FINANCIAL PLANNER™ Professional
For most people, there is never a perfect time to start thinking about a plan for college.
The cost of college is rising at a much faster pace than inflation, making it more important than ever to start saving as early as possible.
Many families expect or rely on more money from grants and scholarships than they are likely to receive.
Around 57% of American families received a need-based grant in 2019, but only at an average amount of $5,732 per year1. While more than half of American families receive this funding, the amount of money received compared to the overall cost of college is relatively small.
The reality is: families are receiving less financial aid, and expected to pick up more of the expenses associated with a college education.
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In this blog article, Morey & Quinn Wealth Partners outlines how federal financial aid is calculated and discusses ways to position your savings to enhance eligibility for financial aid. All of the strategies discussed are legal and are not meant to manipulate the financial aid process, but rather to take advantage of the rules for calculating eligibility.
Expected Family Contribution
The years before a student goes to college, and every year while in college, the student will file a form with the federal financial aid office called a FAFSA (Financial Application for Federal Student Aid). This form uses income and tax information for the students and their parents for the two years prior to college to determine a student’s Expected Family Contribution (EFC). EFC is not the amount your family will pay for college or get in federal aid. It’s a number used to calculate how much aid a student is eligible to receive. Families may be expected to pay more than their EFC.
The formula for EFC is:
|Parent’s Assets & Income||+||Student’s Assets & Income||=EFC|
|Income (22- 47% of income above protected amount*)||Income (50% of income above $6,660)|
|Assets (5.64% of non-retirement assets above protected amount*) Excludes personal residence||Assets (20% of all assets including bank accounts, savings, UTMAs)|
*Protected amounts vary based on household size and number of students in college.
The relevant date for determining whether you own a particular asset is the date that you submit the FAFSA, but the income information is from two years prior, which is referred to as the "base year" (e.g., the 2020/21 FAFSA relies on your 2018 tax return; 2018 is the base year). This is why planning is so important.
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Financial Strategies to Reduce Income
- Delay discretionary income. If you are receiving employment bonuses, it make sense to delay them until after December 31 of your base year. If you are eligible for pension or IRA distributions and plan to take them, it may make sense to delay those. Avoid selling investments that have capital gains, or consider selling investments that can be taken at a loss during the base year.
- Pay taxes during your base year. Pay your taxes before December 31st to reduce the cash you have on hand, and to deduct the tax payments on your FAFSA.
- Leverage student income protection allowance. The student's income protection allowance allows for the first $6,660 of income (for 2019/2020 school year) to be excluded from determining a child’s total income. A student’s earnings beyond the allowance is assessed at 50% for financial aid purposes. The federal government expects your child to contribute 50% of all income earned over the allowance (after taxes). If your child is working and doesn’t need the income to meet daily living expenses, parents may want to consider having their children perform volunteer work once their kids reach the allowance limit.
Financial Strategies to Reduce Assets
- Pay off debt. The FAFSA does not care how much debt you have. If you have $10,000 in assets and $10,000 in debt, they do not offset each other. The federal government still assumes you have $10,000 in assets to help with the cost of college. It may make sense to use cash on hand to pay down consumer debts.
- Make large purchases in advance. If you planned to make a large purchase - such as new furniture, or making a home upgrade or buying a car - and intended to purchase with savings, now may be the time. This will reduce the cash on hand that would be viewed as an accessible asset for college savings.
- Use student assets for the first year. The student or child is expected to contribute 20% of his or her assets each year to college costs and parents are only expected to contribute up to 5.6% of their assets. 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 the child's assets in the first year, the family will likely increase its chances to qualify for more financial aid in subsequent years.
- Leverage parent’s asset protection allowance. Parents have an asset protection allowance, which enables them to exclude a certain portion of their assets from consideration. The amount of the asset protection allowance varies depending on the age of the older parent at the time the child applies for aid (the idea being the closer the parents are to retirement age, the larger the asset protection allowance). Once you know the allowance amount, you can consider saving that amount in cash. Savings above that could be shifted to excluded assets, such as retirement plans, cash value life insurance, or paying down your mortgage.
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Grandparents Can Play a Role Too
Many grandparents are stepping in to help out with the cost of college. The good news is that 0% of income and assets are included in the financial aid formulas when it comes to grandparents.
However, distributions from a college savings plan owned by a grandparent are reported as income to the student, and this income is assessed at the 50% rate on the FAFSA. Parent-owned college savings plans are only assessed at the asset rate of 5.6% and are not counted as student income.
There are ways to avoid having the distribution from a grandparent-owned 529 account count as student income. One way is for a grandparent to delay taking a distribution from the 529 plan until any time after January 1 of the grandchild's sophomore year of college (because subsequent FAFSAs will rely on income tax returns from previous years). Another option is to wait until after the grandchild graduates and use 529 funds to help pay down his or her student loans (there is a $10,000 lifetime limit per 529 plan beneficiary on repaying student loans).
There are several ways a grandparent can help their grandchild pay for the rising cost of college. A financial advisor can work with you to determine the best way for your family’s unique situation and help to minimize estate and/or gift taxes for the grandparent.
By applying strategies that lower your assessable income and assets under the federal formula for financial aid, you lower your EFC, and as a result, your child is likely to be eligible for more financial aid and less current out-of-pocket costs for you. Some of the aid available to you may be in the form of loans that would need to be paid back. However, this may still allow you to be in a better financial position to focus on other priority goals, such as retirement.
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Schedule a no-cost consultation to talk through your college-planning needs. Morey & Quinn Wealth Partners are happy to answer questions and discuss strategies that help position you for the future. Learn how our Omaha, Nebraska-based financial advisors can help you maximize your college planning.
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1 Sallie Mae, How America Pays for College, 2019
Any opinions are those of Katie Bruno, MIMFA, and not necessarily those of RJFS or Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Raymond James does not provide tax or legal services. Please discuss these matters with the appropriate professional.
As with other investments, there are generally fees and expenses associated with participation in a 529 plan. There is also a risk that these plans may lose money or not perform well enough to cover college costs as anticipated. Most states offer their own 529 programs, which may provide advantages and benefits exclusively for their residents. The tax implications can vary significantly from state to state.
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