To get the most financial aid possible for college, you and your child need to understand how the complicated eligibility formulas work. This applies whether the assistance is in the form of need-based scholarships or grants that don’t need to be paid back or federally subsidized loans.
This is especially important in light of the increased competition for financial aid in recent years.
Traps to avoid…
TRAP 1: Waiting until your child’s senior year of high school to think about financial aid. During that year, you can submit the Free Application for Federal Student Aid (FAFSA), starting January 1, and possibly other forms, which may be required earlier. But the financial criteria that determine your financial-aid package are based in part on your family’s income for the entire calendar year before your child enrolls in college.
In other words, the year that really counts is the calendar year that begins January 1 during your child’s junior year of high school and runs through December 31 in his/her senior year. This is known as the first “base income year,” and it’s critical because financial-aid officers use it as a basis for the first year’s financial-aid package.
For many people, it’s important to act in advance of the first base income year to aggressively lower the income that you will report on the aid forms for that base income year (as well as the remaining base income years that follow during college because financial-aid forms must be submitted for each year and your eligibility is reassessed each time).
For aid purposes, your income includes your Adjusted Gross Income (AGI) if you file taxes plus various types of untaxed income. For most families, income plays the biggest role in determining the amount of college costs that your family is expected to be able to pay—known as the “expected family contribution,” or EFC—under various aid formulas.
Ways to reduce income…
Accelerate sales of any stocks or property that you are ready to sell and that will have capital gains. You should do this prior to any base income year. In addition, try to offset capital gains with capital losses during any base income year.
Avoid overpaying state and local taxes in the year prior to the base income year if you are going to itemize your deductions. Reason: If you overpay these taxes in the year before the base income year, you’ll receive refunds for the overpayment during the base year—and these refunds will be considered part of your AGI.
Helpful: It also makes sense to reduce your assets before you file your aid forms because assets are another important factor in determining financial aid. Although you don’t want to go on a shopping spree to reduce the amount of cash you have in your bank accounts, consider paying off credit card and car-loan debt or spending money on a major purchase or project that you were planning anyway, such as buying a new car or fixing the roof on your house.
TRAP 2: Not filing a FAFSA because you believe that your income is too high for you to qualify for aid. There are many other factors that determine aid eligibility, including the cost of the school. In some cases, families with incomes above $100,000 or even $200,000 qualify for assistance—especially if there will be more than one child in college during the same academic year or a child is attending a private college.
TRAP 3: Putting money in your child’s name. If you are otherwise eligible for aid—especially need-based scholarships and grants—avoid custodial accounts (UTMAs or UGMAs) and trust funds. Reason: The federal government and colleges figure that a student should be required to spend a far greater percentage of his own money for college than his parents’ money, so student assets have a far greater impact on lowering your family’s eligibility for financial assistance.
In determining aid eligibility, up to just 5.65% of parental assets are counted in the aid formulas, compared with 20% to 25% of a student’s assets. (Retirement accounts generally are excluded in the aid formulas for both parents and students.)
What to do: Think twice before putting assets in a child’s name.
TRAP 4: Encouraging your child to earn large amounts of money during college years. Some parents push their children to work so much to help pay for college that it cuts into their study time. They may not realize that under the FAFSA formula, once the child’s income exceeds a certain amount in the base income year ($6,130 for the 2013–2014 school year), he may lose 50 cents of financial aid for every dollar above that. For some schools, the trigger number is as low as $4,147.
Exception: Earnings from a federal work-study program are excluded from income in the aid formulas. (For more on federal work-study jobs, see StudentAid.ed.gov. Under “Types of Aid,” click “Work-Study Jobs.”)
TRAP 5: Letting grandparents chip in too directly. Generous grandparents can be an enormous help in funding a college education, but they also can hurt a student’s financial-aid eligibility if their contributions are not handled correctly.
For instance, some grandparents write a check directly to the school to cover a portion of the child’s educational expenses. That’s not a good idea because such payments can reduce financial aid on a dollar-for-dollar basis.
Other grandparents establish 529 college savings plans in their own names with their grandchildren as the beneficiaries. Unlike 529s owned by parents or students, the money in a grandparent-owned 529 doesn’t need to be reported on the FAFSA at all. Problem: Distributions from grandparent 529s are considered part of the student’s base year income, whereas distributions from parent- or student-owned 529s are not counted as income in the financial-aid calculations.
My advice: If your goal is to maximize your financial aid, the grandparents could simply hold off on contributing to the grandchild’s education finances at all until the student graduates, then help him pay off his student loans. Alternatively, if a grandparent already has established a 529 college savings plan, he might wait until after the final financial-aid application for the student’s college years is filed before making a distribution—that typically means after January 1 of the grandchild’s junior year of college.
TRAP 6: Not cooperating with the student’s other parent if you are divorced or separated. Only the “custodial” parent is required to list his income or assets on a FAFSA. That’s the parent with whom the student has lived the majority of time in the 12 months preceding the day the application is filed, regardless of who has legal custody or who claims the child as a dependent on his/her tax returns. The finances of the noncustodial parent are not considered at all by most colleges when awarding aid.
So if you are looking for the biggest aid package at one of those colleges, you may decide to have the child live primarily with the parent who can demonstrate the most need for financial assistance.
However, some colleges—primarily some very selective private colleges and some state universities—do require financial information from the noncustodial parent and his/her spouse when awarding the school’s own financial aid. (That is not the case with federal aid.)
Keep in mind that if the custodial parent has remarried, the stepparent’s income and assets must be included on the FAFSA and possibly other aid applications.