Blonch

Planning ahead makes a big difference!

How you manage your earnings and assets before and during your children’s college years determines the financial aid that your family receives. The choices you make can change your answers when it comes time to fill out the FAFSA questions about your income and assets and will impact your available aid.

Don’t go overboard:

• Financial aid-boosting strategies should be balanced with investment, tax, and financial planning issues and goals.

• Some increased aid might come in the form of grants, but more may be subsidized loans or work-study programs. You may decide to forgo those and tap income or assets instead.

• Be honest. Conviction for lying on a financial aid form is subject to fines and/or a prison time.

There are two formulas for EFC

Two formulas are commonly used to calculate the “expected family contribution” (EFC), which, when subtracted from the cost of attending the school in question, leaves the amount that could potentially be offset by financial aid.

• Federal Methodology (FM) is used to award federal and state financial aid, such as Pell grants, Stafford loans and PLUS loans.
  
• Roughly 600 (mostly private) schools use the Institutional Methodology (IM).
  
• Some schools may also have their own specific forms and formulas.

It’s a good idea to find out the method used by the schools your children are targeting since the resulting numbers can vary widely.

What is a base year and what counts toward the EFC?

Each year you file FAFSA for the coming year using the prior year (base year) income and assets information. Here are how different sources of a family’s income and assets could be included in the EFC.

FAFSA counts Parents’ Income 0 To 47 percent (limit if you can)

• Although it might be difficult to manipulate your salary to minimize the EFC, try to arrange any bonuses to be paid in years before or after the base year.
• When selling assets with capital gains, try to get the sale completed before or after the base year of the financial aid process (the year before you need any money).
• Contributions made to retirement plans (like an IRA or 401k) in any base year are added back into the EFC.

From a financial aid standpoint, it’s better to maximize retirement savings before the children go to college, and then plan on redirecting the otherwise deferred amounts toward paying college costs.

• Parents who are already retired when their children go off to college may be able to minimize pension payments and retirement plan withdrawals so that this portion of the EFC is as small as possible.
• Whether it’s by design or circumstance, if you are in the lower income brackets you may get special treatment by the FM.
  

If the parents meet certain criteria and have income of less than $50,000, the family can qualify for the “simplified EFC,” where assets are not considered in the formula.

• Those with less than $20,000 in adjusted gross income qualify for zero EFC.
  

FAFSA counts Parents’ Assets 0 To 5.6 percent (good stuff)

Savings and investments held in the parents’ names get much more favorable treatment, with an initial amount based on the age of the older parent that is completely free from inclusion.

• Less than 6 percent of the rest of their money will be included in the EFC
• assets in retirement plans may not be counted at all

If you have substantial investments held outside of retirement accounts, you may want to place a portion into an annuity, which, at least under the FM, is considered a “retirement” plan and not counted in the EFC. Of course, there are other factors to consider in this maneuver, such as the costs, benefits and drawbacks of annuities, as well as any capital gains that might be realized when liquidating assets to fund the annuity. Be careful when tapping IRAs or 401ks to pay for college costs as the withdrawals will count as “income” for both tax and financial aid purposes. Instead, consider a loan against your at-work retirement plans, or if you only have IRAs, borrow enough from traditional sources of education loans to cover current college expenses, and then repay the loan with IRA withdrawals after the child graduates.

If you have liquid assets and consumer debt, you could pay the debt down or off and remove the assets from the EFC while saving money on interest. Under the FM home equity is not considered in the formula, so paying down a mortgage will reduce available assets without decreasing net worth. Before you shift assets around for a favorable EFC, make sure you can still get the money easily if the financial aid awarded comes up short. In some states, you can get a line of credit secured by your home equity (HELOC) allowing you to increase the amount of the loan and tap back into the money as needed.

FAFSA counts Student’s Income 0 To 50 percent (keep it under $3,750)

For the 2009-2010 school year FM the first $3,750 of a student’s earned income will be sheltered from inclusion in the EFC. After that, up to half of the earnings will be taken before any aid is awarded.

It is probably better if your student only works enough to earn a few thousand dollars each year, and spends their time on being a student. I told our daughter that her “job” for the next four years was going to school, and that her “pay” was me taking care of the finances. However, after you file FAFSA for their senior year, you can lift the earnings restrictions – even during the second semester of their Junior year and all of their senior year. Just don’t neglect the studying and end up not graduating on time!

FAFSA counts Student Assets up To 25 percent (the only money a kid needs is for 529 Plans)

Money held in the student’s name (like in an UTMA/UGMA account) may offer the family a benefit at tax time, as interest and capital gains earned in the account may be taxed at a lower rate than that of the parents. But for that advantage, families may incur at least two drawbacks: The first, of course, is that the account is technically owned by the child, who may choose to cash it out and spend it as she pleases, instead of on something that pleases her parents.Up to 20 percent of the assets in the student’s name will be added to the EFC each year under the FM, and up to 25 percent under the IM process.If you have money saved in the children’s names, you can try to spend down these accounts for purposes that benefit the child, such as braces, a car, or private elementary or secondary school tuition. You can then deposit money that would have otherwise paid for these expenses into more advantageous investment vehicles.

Another little-known technique is to place the money into a student-owned 529 college savings plan. The family will shelter future gains, income, and qualified withdrawals from taxation. And you may get much more aid under the FM, as UTMA 529s owned by a dependent student will be counted as a parental asset, with no more than 5.6 percent going toward the EFC (the IM may still count an UTMA 529 as a student asset – part of why you need to know what your school counts). If neither of these solutions applies, then at least tap the students’ assets for the first education expenses, and only use other family money or loans when the kid’s money runs out.

You May Still Want More Help

Parents with children nearing college age can review our other postings on this topic and should visit fafsa.ed.gov to learn more about the federal financial application and award process. If you have a senior in high school now, you should file the FAFSA as soon after January 1, 2009 as you can. If you have more time to plan and prepare, you may want seek the aid of a professional in this field. Feel free to contact me if you need help finding a reputable financial planner near you who understands FAFSA and EFC.

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College Costs by PecosJack