When it comes to saving for college, many of us focus on a dollar amount. And it is good to have a goal, whether monthly, annually or over a lifetime, for saving for your child’s college education.
But what many of us don’t consider are strategies for maximizing financial aid for our children when they apply for college. It’s better to pay for college out of savings than to take out student loans, but maximizing financial aid eligibility may net your child some needs-based grants, which don’t need to be paid back.
And if you haven’t saved enough to put your child through college without loans, you’ll have more federal loan options if you can show higher financial need.
One of the keys to maximizing financial aid eligibility is to put your assets in the right place. Sound complicated? It is. But we’re here to break down the financial needs assessment process and to offer some tips for getting the best possible financial aid outcomes.
How Financial Need is Calculated
Financial need is calculated using the Free Application for Federal Student Aid (FAFSA). Even if you have enough in savings to pay for college, it’s still smart to fill out the FAFSA. You’ll fill it out every year after doing your taxes, and the earlier the better.
The FAFSA will ask for a ton of information about your family’s finances, including information about the student’s finances. This information will be fed into a formula that will spit out your Expected Family Contribution (EFC). According to the U.S. Department of Education, your EFC is an index number that individual colleges use to determine how much financial aid you’d receive if your child attended their school.
Your EFC stays the same from one school to the next, but your financial aid package will differ depending on the Cost of Attendance (COA) at each school. The higher the COA and the lower the EFC, the more likely the student is to be eligible for needs-based scholarships, grants and loans.
You can learn more about how the EFC is calculated from the online worksheet.
Certain Assets Count More than Others
Under EFC, assets are not equal. The government’s formula counts some assets as being more available for paying for college than others. Here’s a breakdown of how various assets count toward your EFC:
- Student assets (including savings, investments, business interests and real estate): 20 percent
- Student income: 50 percent
- Parents’ assets (including savings, investments, some business interests, and some real estate and based on a sliding income scale): 2.6-5.6 percent
- Parents’ income (based on a sliding scale after some allowances): 22-47 percent
As you can see, allocating assets so that they’re in the parents’ name(s) rather than the student’s will reduce the EFC, increasing financial aid possibilities.
Where to Put Your Assets
Where to allocate assets for the best financial aid outcomes depends heavily on your situation. Obviously, there are certain tax implications to having assets in a parent’s name rather than a child’s, and whether the advantages will outweigh the disadvantages depends on your circumstances.
Still, there are things you can do while saving for college, or before filling out the FAFSA, that will help boost financial aid possibilities. Here are some suggestions:
Own a 529 Account
A 529 account is a fabulous way to save for your child’s college education because earnings aren’t subject to federal and (most) state income taxes. Withdrawals that are used for qualified higher education expenses also are tax exempt.
Most parents open a custodial 529 account in their name and name their child as the beneficiary. This is an acceptable way to fund a 529 account and is, in fact, the better option for financial aid.
If the account is in the parent’s name (even with the child as a beneficiary), it will be counted toward the EFC at the much-lower parent rate, as long as the student remains the parent’s dependent. If it’s in the child’s name, 20 percent of what’s saved in the account will be added to the EFC for that year.
Prepaid tuition plans also can count as either parent or student assets, depending on how they’re set up. If you choose to save money in this plan, the refund value of the account at the time you apply for the FAFSA will count as an asset. Again, it’s best to set up a custodial account in the parent’s name with the child named as a beneficiary.
A Note on Grandparent-Held 529 Accounts
Grandparents can also open 529 accounts with a grandchild as a beneficiary. On the surface, this would seem to reduce the student’s EFC because grandparent-owned assets don’t count toward it.
However, distributions from grandparent-owned accounts count as income for the beneficiary. While the money isn’t taxed if it’s used for school purposes, it does count as student income on the next year’s FAFSA. That means that 50 percent of the distribution would count toward the student’s EFC.
If a grandparent wants to contribute to college, consider using the grandparent-owned account to fund the last year of college, at which point the year’s taxable income won’t matter.
(Example: If Grandma saves $5,000 in a 529 for Johnny’s education, the asset doesn’t count in the EFC. However, if she gives him that money for college in his freshman year, 50 percent of it ($2,500) will count toward his sophomore year’s EFC. If, however, she gives him the $5,000 in his senior year — provided he’s not going to graduate school — the increase in his income won’t matter.)
Extra State Benefits for a 529
In some states, including Illinois, Indiana, Kentucky, New York, Pennsylvania and Virginia, money held in that state’s 529 plan doesn’t count in calculations for needs-based state education grants. If you live in a state that shelters assets in its own 529 plan, and if you think there’s a good chance your child will attend an in-state college, consider opening an account with your state.
Again, though, whether this will be your best option will depend on your particular needs and financial situation. Each state and Washington, D.C., has its own plan, and each plan comes with different fees and benefits. So be sure you thoroughly compare your state’s plan to other options to ensure it will be the best bet for your child’s college savings.
Other College Savings Accounts
Although the 529 plan is considered by many experts to be the best option for college savings, there are other tax-advantaged college savings accounts, such as the Coverdell Education Savings Account. If you max out your annual savings in your 529 account and want to continue to save for college, a Coverdell can be a good option. Here, too, it’s best if the parent acts as the account’s custodian, since it will be counted as a parent asset if it’s in the parent’s name.
If you need still other college savings options, or if you want to help your child save for other things, consider savings bonds or regular taxable investments. These items can be placed in a parent’s name, which will make their impact on financial aid eligibility lower.
One final savings note: UGMA/UTGA custodial accounts will always count as the asset of the beneficiary. Because of this, these accounts will have a higher impact on financial aid eligibility. Once again, whether this type of account is right for your family will depend upon a host of other financial particulars. But you should know that these accounts will lower your child’s financial aid possibilities.
Spend Down Student Assets and Income First
Because the student’s assets count toward the EFC more, spend down those assets first. There are, of course, easy ways to do this. Use the student’s savings to buy a much-needed car before freshman year. Or just use the student’s savings to pay for the first year of college, boosting financial aid eligibility in subsequent years.
Use Savings to Pay Off Debt
This is something you should do anyway because the interest you’re earning on a savings account is much lower than the interest you’re paying on your credit cards. But because cars, homes and other assets don’t count toward your EFC, paying down debt is a good way to get on track financially while boosting financial aid eligibility.
Maximize Retirement Account Contributions
Again, this is something you should be doing anyway. But if you have money in other savings accounts, use it to max out your retirement investments before filing the FAFSA. Alternatively, you can plan to max out your savings every year with automatic deductions from your paycheck.
Since retirement accounts don’t count toward your EFC, this reallocation of your assets will increase student aid possibilities, while setting you up for a better financial future.
You should also consider having your child save for retirement from an early age. This will also help shield some of your child’s earnings from the EFC. And even if you think it’s too much to save a lot for retirement, some of the money could be withdrawn for a down payment on a house.
Accelerate Other Expenses
If you (or your student) needs a new car or computer, buy it before you file the FAFSA. If the item is for your student, buy it with his or her money, if possible.
You can also use your savings to accelerate other expenses. Prepay your mortgage, since your primary residence doesn’t count as an asset for FAFSA purposes, or prepay other bills.
Pay for Your Own Degree
If you’ve been looking to go back to school, consider going when your child starts school. The total Expected Family Contribution is typically split across all family members enrolled in college, so putting some money into your education now can be a good investment.
Because of the fraud that surrounds this loophole, it’s not as easy to get as it once was. Now, schools are allowed to apply this exception at their discretion. Your child’s school may verify your enrollment for an actual degree at your school of choice.
The school may also choose to reduce your family’s income by the amount you’re paying for school, rather than increasing the total number of students enrolled.
Talk to a Professional
If your family has significant assets, you may need to talk to a professional about asset allocation for student aid outcomes.
For instance, once your child turns 18, you can reap some serious tax savings by putting as much as $26,000 in his or her name, even if they’re still a dependent, for FAFSA purposes. But the same move that nets you some tax savings could seriously reduce financial aid eligibility.
If you’ve already put assets in your child’s name, you may want to talk to an accountant about how to legally spend them down. You can’t technically spend a child’s assets on the things you’re responsible for as a parent — food, shelter, medical care, etc. But you can spend them on extra things for the child’s benefit — art classes, summer camp, etc.
As you can see, the process of allocating assets so that you can get the most out of financial aid is enormously complicated. Whether you have a lot of assets or only a few, learning a bit about this process will help ensure your child gets the most possible financial aid and you have the least possible out-of-pocket education expenses.