Removing the Mystery from College Financial Aid

One of the many great mysteries for parents with college age children is “How is the amount of federal student aid determined?”

This mystery begins as you tackle the gauntlet of filling out and submitting the Free Application for Federal Student Aid (FAFSA) form.  You do your best to fill out this form accurately reporting the assets and income of your family.  I apologize upfront that I won’t be able to solve the entire financial mystery for you in the this short blog but at least I can shed some light on some of the general concepts which could allow you to better organize your family’s assets to better take advantage of available financial aid for college.

Need-based financial aid for college is not just based upon family income; it is also based on how much a family has saved and in what type of financial instrument those savings are being held.  The financial aid calculator takes a small amount of the parent’s income and assets and sets them aside as an allowance for minimal living and excludes that from the calculation.  Income and assets above those parental allowances, plus just about all of the student’s income and assets are then subjected to various percentage rates.  This calculation determines the “Expected Family Contribution (EFC)” or the amount a family is considered to have available to put towards college costs for that year.  The formula counts the following resources as being available to pay college expenses:

·         20% of a student’s assets (money, investments, business interests and real estate)

·         50% of a student’s income (after certain allowances)

·         2.6% – 5.6% of a parent’s assets (money, investments, business interests and real estate; based on sliding income scale)

·         22% – 47% of a parent’s income (based upon a sliding income scale)

Qualified retirement accounts such as traditional IRA’s, Roth IRA’s, or 401(k)s whether owned by you or your child are not counted in determining EFC for purposes of federal financial aid.  The equity in your primary residence, a family-owned business, insurance policies and annuities are also excluded from your assets in the EFC calculation.

Assets that belong to the student result in a greater reduction in financial aid.  Custodial accounts such as UGMA/UTMA accounts are considered assets of the student.  Financial aid formulas track 529 plans and Coverdell ESAs as assets of the parent, so as long as the student beneficiary is listed as a dependent on the parent’s tax return.  Any 529 plans owned by a grandparent or anyone else are not counted as assets for federal financial aid eligibility.

Note that some colleges can calculate financial need using different formulas when offering their own grants and tuition discounts.  Some colleges may count home equity, sibling assets and certain investment accounts differently than this federal methodology.

I hope this has solved some of the mystery surrounding the federal student financial aid computations and gives you some thoughts on how to position your assets and those of your children so as to best take advantage of college financial aid.

–Scott Goldstein, Partner, CPA