Intro to College Savings - Lesson 5

http://www.savingforcollege.com/articles/intro-to-college-savings-lesson-5

How will my savings affect financial aid?

Most college students today receive some type of financial aid—loans and/or grants—to help pay for college. The federal government, state governments, and colleges themselves are the major sources of financial aid, although many employers and charitable organizations provide educational assistance as well.

Much of the financial aid made available to your child is “needs-based.” This means that he or she must demonstrate financial need through a process that begins with submitting an application listing the student’s—and in most cases the parents’ as well—income and assets.

All federal aid programs involve a form called the Free Application for Federal Student Aid, or FAFSA. Using the information submitted with the FAFSA, the federal government applies a rather complex formula to determine the student’s Expected Family Contribution, or EFC. A student with a low EFC will generally be eligible for more need-based financial aid than a student with a high EFC.

Remember, even if a student is not eligible for any need-based financial aid, he or she will still be able to receive federal Stafford loans, and the student’s parents will likely be eligible for federal PLUS loans as well.

Student assets and income

Student-owned investments listed on the FAFSA will increase EFC by 20 percent of the value of those investments as of the day the FAFSA is filed. A student’s income above a threshold amount will increase EFC by 50 percent of that income.

It’s easy to see how a stock or mutual fund owned directly by a student, or owned indirectly through a Uniform Transfers to Minors Act (UTMA) account, can have a severe negative impact on financial-aid eligibility. Not only will the value of the asset affect EFC by a significant percentage, but the sale of the investment to pay for college could trigger a capital gain that gets assessed at a 50 percent rate as part of the student’s income.

Parent assets and income

Most undergraduate college students are categorized as “dependent students” and must report parent assets and income on the FAFSA. Just like student assets and income, parent assets and income are assessed in determining the student’s EFC, except the percentages are lower, and they are based on a sliding scale that adjusts with income.

Parent assets increase EFC by no more than 5.64 percent of the value of those assets on the day the FAFSA is filed. Parent income increases EFC by no more than 47 percent of that income. Assets and income are first reduced by several allowances built into the aid formula.

Special treatment for 529 plans

So as not to discourage families from saving for college with 529 plans, a special provision was added to the financial-aid law several years ago that categorizes a student-owned or UTMA-owned 529 plan as a parent asset. The rule also applies to Coverdell education savings accounts.

Because of this exception, a 529 plan will never affect EFC by more than 5.64 percent of its value. It will behoove many students that have investments in their own name, or in UTMA accounts, to sell those investments and move the proceeds into a 529 plan before filing the FAFSA. However, watch out for any capital gains that may result in making the switch.

Using a 529 plan to pay for college will not cause any increase in income reported on the FAFSA—another significant advantage over taxable investments!

529 plans may have zero impact on aid eligibility

If a student’s family is eligible to file its federal tax return on Form 1040EZ or Form 1040A, assets are not counted at all in determining the EFC. This is known as Simplified EFC.

And even if the family cannot file Forms 1040EZ or 1040A—most likely because their income is too high—the parents’ assets, including 529 accounts, may be less than the asset allowance on the FAFSA. Only their income will be taken into account.

What about grandparents?

A student will never have to report assets owned by grandparents or other third parties on the FAFSA, even when those assets consist of 529 plans or other investments targeted to the student’s college expenses. That’s the good news.

The bad news is that 529 plans or other accounts actually spent on the student’s behalf must be added to the student’s income on the following year’s FAFSA, which can result in a significant increase in EFC.

Grandparents with 529 plans may wish to target that money towards the final year of college, after the last FAFSA has been filed. This way, their assistance has no impact on aid eligibility.

Other financial-aid formulas

The FAFSA does not necessarily determine financial-aid eligibility for state-funded aid programs, school-based scholarships, or other non-federal sources of aid. Although many schools do use the FAFSA for distributing their own funds, some will employ an alternative formula using another application called the CSS Profile.

Before deciding which college to attend, you should ask the school about their own aid programs and how they treat 529 plans in determining eligibility.

Mistakes families make

The biggest mistake you can make is to spend your assets on home improvements, a new boat, or other items in an attempt to increase your child’s eligibility for need-based financial aid. Your income level alone may prevent your child from qualifying for this aid, and your spending now leaves you short of funds.

Having the savings set aside in a 529 plan is much better. Not only is there likely to be little or no impact on aid eligibility, but having the funds set aside means that your child can attend the college that is right for him or her, and not necessarily the college that offers the best aid package.

Congratulations! You’ve completed the College Savings Bootcamp. Now it’s time to open your 529 plan and start making contributions. The earlier you start to save, the better.

Be sure to come back to often and follow us on Facebook to get the latest news and information on planning for college.

Previously sent:

Lesson 1: How much to save

Lesson 2: Compare your options

Lesson 3: Shop for a plan

Lesson 4: Get family and friends involved