Tuesday, February 15, 2011

Q&A Series - Which Assets Affect Financial Aid Eligibility?

This week's question comes from Elizabeth, a reader whose daughter will be starting college in the fall.

Q: We’re starting the financial aid application process, and I’m confused about what assets affect eligibility. What assets are included in the eligibility calculation?

Congratulations, Elizabeth! After years of laughter, tears and arguments, the day your daughter heads off to college is just around the corner. With the amount of college students applying for financial aid, I have a feeling that many of our readers will find this topic interesting, so thank you for your question.

The Basics

Financial aid is structured to help make up the difference between what a family is able to pay and what a college charges. The basic idea is that everyone, regardless of means, should be given the opportunity to go to college.

The majority of financial aid is provided at the federal and state levels, and includes interest-subsidized loans, work-study programs, and grants. Every year, the Federal Student Aid office of the U.S. Department of Education provides more than $150 billion in new aid to approximately 14 million college students. It’s important to note that not all schools participate in the Federal Student Aid programs, so it’s best to check with your school to find out what programs are available.

The first thing to do to access financial aid is apply for it, usually by using the Free Application for Student Aid (FAFSA) form or by completing a specific college’s financial aid form. Both use similar formulas to determine how much need-based aid your child is eligible to receive.

The three basic components of that formula are the cost of attendance (COA); the total resources provided to a child from outside sources (like a scholarship) which reduces the COA on a dollar-for-dollar basis, and; the amount your family is expected to contribute to your child’s college costs based on your particular financial situation, which is called the “Effective Family Contribution” (EFC). Subtract the Resources and EFC from the COA and you arrive at the Financial Need that the aid package will try to cover.

Be sure to pay attention to the deadlines for submitting your student aid application! There are federal and state deadlines, and your college may also have a deadline. The federal deadline for online applications for the 2010-2011 school year is midnight Central Daylight Time, June 30, 2011.

If you’re not sure you’ll qualify, I suggest you apply anyway. The application is necessary for obtaining government-sponsored loans and you may be surprised with how much aid is extended to you.

What Counts, What Doesn’t

According to SavingForCollege.com, the formula to compute EFC uses the following financial resources 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 interest, and real estate, based on a sliding income scale and after certain allowances)
  • 22%-47% of a parent’s income (based on a sliding scale and after certain allowances)
For divorced parents, the custodial parent is responsible for completing the FAFSA. It should be noted that any child support and/or alimony received from the non-custodial parent must be included on the FAFSA. The Federal government does not consider the income and assets of the non-custodial parent in determining a student’s financial need.

Fortunately, neither a parent’s nor a child’s qualified retirement assets (investments in 401(k) plans, regular or Roth IRAs) are considered a resource. This makes sense, since those assets are vital to your own and your child’s long-term future. The basic components to determining your EFC are your current income and non-retirement assets. The equity in your primary residence, a family-owned business, insurance policies, and annuities are also excluded from your assets when determining EFC.

How to Increase Aid Potential

Since a child’s own assets and income are reported on financial aid applications at a much higher rate than those of their parents, it’s advantageous to have fewer assets in the child’s name and more in the parents’ names. For that reason, 529 plans tend to be a better choice than custodial accounts. Assets in 529 plans are considered to be the parents’ if the child is a dependent on your tax return. They generally have a fairly low impact on a student’s financial aid eligibility, usually a maximum of 5.6% of the value. On the other hand, custodial accounts are the student’s assets and are assessed at 20% in most cases.

Also worth looking into are 529 plans established in a relative’s name for a child. If a 529 plan is set up this way, it won’t factor into the financial aid application at all. This is because the relative who is contributing – not the parents or the child – owns the account.

Withdrawals from 529 plans expressly used for college expenses are also favorably treated. Because withdrawals of that nature are excluded from your federal income tax return, they are not required to be included as income on the FAFSA.

On the other hand, withdrawals from retirement accounts for college expenses aren’t treated as advantageously. While you can take money out of your Roth or traditional IRA for qualified college expenses penalty-free, it may put your financial aid eligibility at risk the following year. The entire withdrawal plus principal and earnings count as income on the following year’s application.

As briefly touched on above, it’s also unwise to withdraw IRA assets to pay for your child’s college expenses because it infringes upon your own retirement preparation. I cannot stress enough that you should never pay for your child’s postsecondary education instead of saving for your own retirement during your working years.

Additional Resources on Financial Aid

FAFSA official website
Federal Student Aid on the Web
FinAid! The Smart Student Guide to Financial Aid

Elizabeth, thanks again for your question. I hope my explanation has given you some understanding of the financial aid process and the components that might affect your daughter’s eligibility. Good luck to both of you in this exciting new chapter of your lives!

We encourage our clients and readers to send us questions for our Q&A series at contact@rollinsfinancial.com. And as always, we hope you will keep Rollins Financial in mind when seeking professional advice on financial planning and investing.

Best regards,
Joe Rollins

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