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Financial aid basics
Financial Aid and Your Savings
[Excerpted from Savingforcollege.com’s Family Guide to College Savings]
In order to determine the investment mix that offers the most favorable impact on your child's federal financial aid eligibility, let's first look at how the formula for computing EFC works. The formula counts the following financial 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, certain business interests, and real estate, based on a sliding income scale and after certain allowances)
- 22%-47% of a parent's income (based on a sliding income scale and after certain allowances)
Now let's see how specific types of assets affect the aid formula:
- A good type of asset to own when applying for financial aid is
a retirement account such as an IRA or 401(k). These qualified retirement
accounts, whether owned by you or by your child, are not counted at all in
determining EFC for purposes of federal financial aid. Be careful, however,
about taking money out of your IRA (or any retirement account) to pay for
college. Though the tax law now permits penalty-free withdrawals from a traditional
or Roth IRA to pay for qualified college costs, doing so could jeopardize
financial aid in the following year. The entire withdrawal, principal and
earnings, counts as income on the following year's aid application.
- The equity in your primary home, a family-owned business, insurance policies, and annuities are also
excluded from your assets when determining EFC.
- Assets that belong to the student result in a greater reduction in financial
aid. UGMA/UTMA accounts are counted as the student's asset. In addition, they
may increase the student's included income to the extent that interest, dividends,
or capital gains are reported on the student's income tax return.
Often the income tax benefit of setting aside investment assets in a child's name is more or less offset by the reduction in the child's financial aid package.
- 529 plans and Coverdell ESAs may be two of the better options to save for
college without jeopardizing financial aid. Congress has bestowed these investments with special advantages for aid-eligibility purposes.
If a parent owns the 529 account or ESA, up to 5.6% of the value is included in EFC as a parent asset. If grandparents own the account, none of the value is included.
A 529 account or ESA owned by a dependent student, or by a custodian for the student, does not have to be included with other student-owned investments. Starting with the 2009-10 school year, such accounts are to be reported on the federal aid application (FAFSA) as parental assets.
Withdrawals from 529 plans and ESAs are also treated advantageously. Such withdrawals when used for college are excluded from your federal income tax return, and except for withdrawals from a 529 plan owned by a grandparent or other third party are not required to be "added back" when reporting income on the FAFSA.
Note that some colleges will calculate financial need using a different formula when offering their own grants and tuition discounts. The "institutional methodology" used by many of these colleges may count home equity, siblings assets, and certain investment accounts in a manner that differs from the federal methodology.