By Julie Ford
If you’re a parent, the thought of college costs for your kids has no doubt crossed your mind. It’s no secret that higher education is becoming more expensive by the year. As a parent, I sympathize with those of you who break out in a cold sweat when you start to think about how you’ll put your kids through college. In this post, I’d like to share how you can maximize your child’s potential for need-based financial aid.
Before we start, let me attempt to lower your anxiety with this encouraging fact: most students (especially at private colleges) pay a very discounted price on tuition after you factor in scholarships, grants and need-based aid. This is the difference between the sticker price (the stated cost of tuition on a college’s website) and net price (what the average student actually pays after scholarships, grants and financial aid). Recently, more and more information about this gap between sticker and net price is becoming available. This article features a helpful interactive graph that shows both the sticker price and net price by income levels for lots of colleges. Some colleges now provide information on net price on their websites.
How Your Assets Impact Aid
Let’s get back to financial aid and talk about how various types of assets will impact your child’s potential for federal need-based aid.
Assets Ignored by Aid Calculations
Parent’s retirement accounts
Retirement assets are ignored; however, distributions are treated as taxable income and will impact aid formulas in the following year.
Business assets
If you’re a small business owner, your business assets will be excluded due to a special exclusion for small business that are “family-owned and controlled.” However, any income from your business will be included in aid calculations.
529 Distributions
While the account value of a 529 account impacts aid (see below), qualified distributions do not impact aid.
Primary residence
As a parent, your home (and mortgage) is excluded from calculations. However, some private colleges will consider your primary residence an asset.
Low Impact Assets
529 accounts in the parent’s name
Money in a 529 account is treated favorably, only reducing aid by 5.6%. Distributions from 529 accounts do not count as income and as such have no impact on aid.
Parents’ assets
Parent assets are assessed on a tiered system ranging from 2.6% – 5.6%. A portion of the parent’s assets will be ignored based on age and there are a few categories of assets that are ignored entirely by federal aid calculations (e.g., retirement accounts, primary residence, small business assets).
Non-retirement assets in parent’s name
This category includes all checking, savings, investment accounts and real estate and is considered a low impact category, reducing aid by 2.6% - 5.6%.
High Impact Assets
Child’s assets & income
Assets in the child’s name reduce aid by 20% (i.e., every dollar in the child’s account will reduce need-based aid by 20 cents). In addition to a savings or checking account in the child’s name, trusts and UTMA/UGMA accounts are also considered to be in the child’s name. If your child is earning income while applying for aid, this will reduce aid by 50%, after certain allowances.
Parent’s income
After certain allowances, the parent’s income will reduce aid by 22% - 47%.
Strategies for maximizing aid
Now for ideas on how to maximize aid. You’ll hear the term base year used a lot in association with the financial aid application (FAFSA). The base year is the tax year prior to the year your child begins school and is tax information you’ll use when filling out the application (for example, the 2016-2017 school year application will use your 2015 tax year information).
Sidenote: Starting with the 2017-2018 school year, this will change and it will be the “prior-prior year” that’s considered your base year. What this means is that the FAFSA for the 2016-2017 year will be based on 2015 tax year information AND the 2017-2018 will also be based on the 2015 tax year.
Rule #1: Keep assets out of your child’s name
Use a 529 to accumulate college savings
Encourage generous family members to use a 529 account rather than a trust or UTMA/UTGA when planning gifts or inheritance for the child
Rule #2: Reduce income for years which the child plans to apply for aid
Delay distributions from retirement accounts
Maximize contributions to retirement accounts. This may lower income and will also reduce money in non-retirement accounts like your checking and savings which impact aid.
Rule #3: Accelerate large expenses for years which the child plans to apply for aid
Accelerate mortgage payments (reduces money in the bank which increases aid)
If you’re already planning to buy a new car, do so in a year you’re applying for aid to reduce assets (again, this reduces money in the bank which increases aid)