Or is your growing college fund wiping out your financial aid?
The more you save for college, the less chance you have of receiving financial aid. This irony has created the urban legend that you will be better off if you don’t save and accumulate debt, so the government will pay for your child’s education. As a responsible parent or loving grandparent, you want to save for your future college education, but you don’t want those savings to jeopardize your child’s chances of getting the best financial aid.
How to avoid or reduce the effects of this paradox?
When saving for college, keep your assets in a way that has the least effect on your expected future family contribution, or EFC. Financial aid is determined by first calculating the EFC – how much of student and parent assets and income are expected to be used for college expenses each year. Parents and students complete a FAFSA (Free Application for Federal Student Aid) form to provide information about their income and assets to schools. Schools use the EFC calculation derived from the FAFSA to offer grant and / or loan aid packages to fund the difference between the EPC and the total cost of tuition, room and board.
What is the expected contribution of income from students and parents?
Income calculated after assignments *:
Student income 50%
Parental income 22-47% (based on income level)
* Allowances include: federal and state taxes, social security contributions, “income protection” ($ 19K for a family of four), and “employment expenses” ($ 3,100, typically).
Student income includes:
- Income from employment, business, hiring
- May include 529 Plan withdrawals, if owned by someone other than the parent (such as grandparent)
- Income from a trust or partnership (in some cases)
Parents’ income includes:
- Income from employment, business, hiring
- Income from non-retirement assets (real estate, stocks, mutual funds, bonds, cash)
- Withdrawals from IRA accounts and / or other retirement accounts
- May include annuity distributions
- Parental-owned 529 Plan withdrawals
- Educational IRA withdrawals
Income may change from year to year depending on how the EFC was funded the previous year. For example, if the parents withdrew $ 10K from their IRA to pay for tuition, that withdrawal, although without a tax penalty, is included in the parents’ income and increases the EFC for the following year. However, the $ 10K withdrawn from a 529 Plan is not included in the parents’ income and does not affect the EFC.
What is the expected contribution of student and parent assets?
Student Assets 35% (drops to 20% for the 2007-2008 school year)
Parent assets 2.6-5.64%
- Accounts and assets owned by the student, directly
- Custodial accounts
- UGMA / UTMA accounts
- Trust accounts
- Coverdell ESA / Education IRA (may be changing)
- Savings bonds in the name of the student
- Taxable accounts and investments (non-retirement)
- 529 plans (owners)
- 529 plans within a UGMA / UTMA for the child (as of July 1, 2006)
- Savings bonds
- Real estate investment
- Retirement accounts (for example, IRA, Roth IRA, 401 (k), 403 (b), pension)
- Equity in primary residence
- Life insurance
- Withdrawals from 529 plans and educational IRAs
- 529 plan if the owner is not the parent or the student (eg, Grandparent)
Obviously, the most advantageous position is that the assets are not included in the calculation. Otherwise, you’ll want to keep assets as parent assets, rather than student assets, to reduce the EFC.
What other considerations are there?
- Some schools perform their own calculations and may include other assets, such as equity in the primary residence.
- Tax considerations on gifts, inheritance, and generational omission: For example, grandparents may need to transfer assets to parents or student to reduce future grandparent succession.
- Parents and grandparents may want to maintain control over assets by retaining ownership or placing restrictions on assets (such as through a trust).
- Accounts directly in the child’s name, custodial accounts, UGMA / UTMA, and some trust accounts come under the control of the child when he or she reaches the age of majority (in California, age 18).
- Parents should be careful to reduce their retirement savings to finance college.
- Several types of accounts have tax benefits, or penalties, if they are withdrawn to fund higher education expenses.
- Accounts have different returns, risks, and fees, which can greatly affect your ability to fully fund college expenses.
- Funds within a 529 Plan are subject to penalties and income taxes if they are withdrawn for non-educational uses, with a few exceptions.
- Multiple funding strategies can be used to take advantage of different options and benefits: for example, a 529 Plan to fund the early years of college and an IRA to fund the senior year.