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COLLEGE SAVINGS 101

Need-based financial aid strategies

12/23/2009

QUESTION:
Dear Joe,

I bought a zero-coupon bond for my daughter when she was an infant for $4,000 under the Uniform Gift to Minors Act. I thought it would be a little something for her college and is currently worth $12,000. She is now 16 and will be a high school senior next year. However, I'm thinking it will go against her when we apply for financial aid next year. On top of that, I have squirreled away $180,000 for a down payment for an apartment in New York. This money is under my name in two online bank accounts. I'm sure this will go against us unless I withdraw it. That is a double-edged sword though because if I don't have the money in the bank, I'm sure it will be impossible to get a mortgage! Just one more bit of information, I earn an annual income of approximately $100,000 per year. Can you PLEASE guide me? Thank you.

-- Liz

ANSWER:
Dear Liz,
To answer your question, I went online to the College Board's Expected Family Contribution, or EFC, calculator, a terrific tool for estimating a student's need-based financial aid eligibility. The College Board's calculator has been updated for the 2010-2011 school year and computes the student's Expected Family Contribution under the federal methodology, or FM, and the institutional methodology, or IM.

The federal methodology is the formula used by the U.S. Department of Education to determine the maximum amount of need-based federal student aid -- grants, subsidized loans and work study -- an eligible student can receive for the upcoming school year. Due to resource constraints, there is no guarantee that the student will receive the maximum, and the mix of aid is determined to some extent by the school's financial aid office. The institutional methodology is a formula derived by the College Board that schools may decide to use, or not use, in determining eligibility for aid coming from the school's own financial aid programs.

Because the financial aid formulas are so complicated, the EFC calculator asks for a lot of information. I made things as simple as I could by making just a few basic assumptions from the information you provided.

For the sake of exploring your options, I've changed your scenario slightly to have your daughter start college in September 2010. So, I'm assuming a 40-year-old single mom living in New York with one 17-year-old daughter. Mom earns $100,000 from her job and $5,000 in interest from her $180,000 savings account while her daughter earns $1,000 from her job and $500 from her zero-coupon bond (worth $12,000). Mom pays $16,000 in federal income taxes while her daughter pays zero. Everything else was assumed to be zero or relied on the calculator's default values.

The results show your daughter with an expected family contribution of $30,302 under the federal methodology, broken down between $27,902 in parent contribution and $2,400 in student contribution. Under the institutional methodology, the EFC is $21,733, consisting of $16,983 in parent contribution and $4,750 in student contribution.

This means that your daughter attending a college costing $40,000 would be eligible for up to $9,698 in federal grants, subsidized loans and work study. The $9,698 is the difference between the school's cost of attendance ($40,000) and the expected family contribution under the federal methodology ($30,302). If the school utilizes the institutional methodology for its own need-based scholarships, your daughter would be eligible for as much as $18,267 -- $40,000 less $21,733 -- although any scholarships or tuition waivers have the effect of reducing federal aid eligibility.

Keep this in mind: If your daughter attends a college with a cost of attendance below $30,302, she will not be eligible for need-based federal aid. She can still receive an unsubsidized federal Stafford loan, and you can apply for a federal PLUS loan.

Now let's use the EFC calculator to see how various "what-if" scenarios affect financial aid eligibility. We'll stick to the federal methodology, although you can easily apply the same adjustments to the institutional methodology.

The first alternative is for your daughter to eliminate her reportable assets by redeeming her zero-coupon bond and purchasing a car for $12,000. This must be done prior to her filing the Free Application for Federal Student Aid, or FAFSA, and will reduce her expected family contribution from $30,302 to $27,902. The calculator shows that it eliminates the student contribution entirely, leaving only the parent contribution to expected family contribution.

The second alternative is to have your daughter keep her $12,000 bond, but have you purchase a home with a down payment of $180,000. Because the federal methodology does not count equity in the primary residence as an asset, your contribution is effectively reduced from $27,902 to $18,675. Your daughter's contribution remains at $2,400, resulting in an expected family contribution of $21,075. (Note: The institutional methodology counts home equity and so this move would not impact eligibility for institutional aid from a school that uses the IM.)

If you and your daughter made both moves to reduce your assets, expected family contribution under the federal methodology is reduced from $30,302 to $18,675 and she becomes eligible for as much as $11,627 in additional federal student aid.

Remember, this is a scenario where there are zero countable assets. Obviously, income is a major factor in computing aid eligibility. And, if mom were to receive a $20,000 bonus, resulting in an added $5,000 federal tax bill, her contribution to expected family contribution jumps from $18,675 to $24,544. If your daughter were to take another part-time job and earn an extra $5,000, her contribution to EFC increases from zero to $576.

I encourage you to take some time with the expected family contribution calculator now, while your daughter is still more than a year away from applying for financial aid, and consider any easy moves you might make to enhance eligibility. And don't think that withdrawing your $180,000 from the bank and moving it under your mattress will help. The money must be reported as your asset in either case.

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