The more you save for college, the less chance you have at financial aid. This irony has created the urban legend that you will be better off if you don’t save and rack up debt, so the government will pay for your child’s education. As a responsible parent, or a loving grandparent, you want to save for the education of your future collegian – but you don’t want those savings to jeopardize any chance your child has at the best financial aid.
How can you avoid or reduce the effects of this paradox?
When you save for college, hold your assets in a manner that will have the least affect on your future Expected Family Contribution, or EFC. Financial aid is determined by first calculating the EFC - how much of student and parental assets and income are expected to be used for college expenses each year. Parents and students complete a FAFSA form (Free Application for Federal Student Aid) to provide their income and asset information to schools. The schools use the EFC calculation derived from the FAFSA to offer aid packages of grants and/or loans to fund the difference between the EPC and the total cost of tuition, room & board.
What is the expected contribution from student and parental income?
Income calculated after allowances*: Student Income 50% Parental Income 22-47% (based on income level)
*Allowances include: federal and state taxes, social security contributions, “income protection” ($19K for family of four), and “employment expenses” ($3100, typically)
Student Income includes:
Income from employment, business, contracting
May include withdrawals from 529 Plan, if owned by someone other than the parent (such as the grandparent)
Income from a trust or partnership (in some cases)
Parental Income includes:
Income from employment, business, contracting
Income from non-retirement assets (real estate, stocks, mutual funds, bonds, cash)
Withdrawals from IRAs and/or other retirement accounts
May include annuity distributions
Not included:
Withdrawals from 529 Plan owned by parents
Withdrawals from Educational IRAs
Income may change for year to year depending upon how the EFC was funded the year before. For instance, if the parents withdrew $10K from their IRA to pay for tuition, that withdrawal, while without tax penalty, is included in the income of the parents, and raises the EFC for the following year. However, $10K withdrawn from a 529 Plan is not included in the parent’s income and does not affect the EFC.
What is the expected contribution from student and parental assets?
Student Assets 35% (drops to 20% for 2007-2008 school year) Parent Assets 2.6-5.64%
Student Assets:
Accounts & assets owned by the student, directly
Custodial accounts
UGMA/UTMA accounts
Trust accounts
Coverdell ESA / Education IRAs (may be changing)
Savings Bonds in the student’s name
Parental Assets:
Taxable accounts & investments (non-retirement)
529 Plans (owners)
529 Plans inside a UGMA/UTMA for the child (as of 7/1/2006)
Savings Bonds
Investment real estate
Not Included:
Retirement Accounts (e.g., IRA, Roth IRA, 401(k), 403(b), pension)
Equity in primary residence
Life insurance
Annuities
Withdrawals from 529 Plans and Education IRAs
529 Plan if owner is not parent or student (e.g., grandparent)
Obviously, the most advantageous position is for assets to not be included in the calculation. Otherwise, you would want hold assets as parental assets, instead of student assets, to reduce the EFC.
What are other considerations?
Some schools perform their own calculations, and may include other assets, such as equity in the primary residence.
Gift, estate, and generational-skipping tax considerations – for example, grandparents may need to transfer assets to the parents or student to reduce the grandparent’s future estate.
Parents and grandparents may want to maintain control over assets by retaining ownership, or placing restrictions on the assets (such as through a trust).
Accounts directly in the child’s name, custodial accounts, UGMA/UTMA, and some trust accounts, become under the child’s control at their age of majority (in California, at age 18).
Parents should be wary of reducing their retirement savings to fund college.
Various types of accounts have tax benefits, or penalties, for withdrawal to fund higher education expenses.
Accounts have differing returns, risk, and fees, which may greatly affect their ability to fully fund college expenses.
Funds inside a 529 Plan are subject to penalty and income tax if withdrawn for non-educational uses, with some exceptions.
Multiple funding strategies may be used to take advantage of the varying options and benefits: for example, a 529 Plan to fund the first few years of college and an IRA to fund the final year.