More than half of college undergraduate students received federal financial aid last year, the College Board found.
Parents are also taking on a larger share of paying for college, Sallie Mae reports. With college costs rising, families want to maximize a student’s ability to receive aid. Most families pursue financial aid with the Free Application for Federal Student Aid (FAFSA) program. There are also some 300 colleges that require a CSS (College Scholarship Service) Profile in addition to the FAFSA to determine eligibility for non-government aid such as a college’s own grants, scholarships, and loans.
A core element of eligibility is calculating what the family is able to pay. The expected family contribution (EFC) is subtracted from the student’s cost of attendance to determine need.
Because the calculation considers the income and assets owned by the student, as well as their parents’ income and assets if the student is a dependent, it is important for families to understand the impact of those assets and account ownership on aid.
Ownership and eligibility
Generally, parent assets are not weighted as heavily as a child’s assets for financial aid. To calculate the EFC, 20% of the child’s assets are taken into account, while a maximum of 5.64% of parent assets are considered.
College savings accounts such as a 529 plan or Coverdell Education Savings account are considered parent assets, unless owned by a non-parent. Accounts in the child’s name such as custodial accounts are assets of the child. For FAFSA, non-parent-owned assets, such as a 529 owned by a grandparent, are not considered. However, these accounts are included in the CSS Profile.
For the FAFSA, 50% of a student’s income is counted. Income is also broadly defined and includes wages as well as distributions from a 529 or Coverdell owned by a non-parent. Roth IRAs (owned by the parent or student) are not included as assets, but distributions from IRAs, including Roth, are considered income.
There are various planning strategies that families can use to try to mitigate a potential limitation on financial aid.
Here are some planning strategies:
1. When a student is the beneficiary of a 529 plan owned by a grandparent or other non-parent relative, a distribution is counted as income for the student. Consider changing ownership to the parent before filing for financial aid. At that point, the account would be reported as a parent asset, but it would be weighed less in the EFC asset test than if it were a distribution reported as income.
2. Before tapping into a grandparent-owned account, wait several years until all of the financial aid applications are completed. In the interim, spend down a parent-owned 529 plan first.
3. Avoid liquidating appreciated assets such as mutual funds that may result in large capital gains, which increase adjusted gross income (AGI) and have a negative effect on financial aid.
4. If possible, execute a Roth IRA conversion before college and prior to the tax year in which the financial aid application is based. The transaction will affect AGI. Also, consider paying the tax bill on conversion from other assets that may reduce total assets considered for the FAFSA.
Many families seek resources to try to determine how much to save or borrow. The College Board, for example, offers a calculator to help families estimate the EFC. It’s important for financial professionals to engage families in advance of college to explore strategies to optimize financial aid, develop a plan.
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