Reflections

FAFSA Myths Busted: How affluent families might still qualify for aid

Understand how your income and assets may work against you when you apply for aid

Parents of incoming high school seniors take note: financial aid registration for the 2018-19 college school year begins October 1.  If you are planning on skipping the FAFSA because you think your child won’t qualify, think again.  Filling out the FAFSA (Free Application for Federal Student Aid) may feel like taking the SAT, but without completing the application, students aren’t eligible for federal student loans, and some schools won’t award merit scholarships or even allow students to apply for campus employment.

And what’s more, there is a chance you can save money on college after all.  If you’d like to understand how your income and assets may work against you when you apply for aid, here’s the truth on four commonly held financial aid myths. 

Myth #1: We earn too much to qualify for student aid

Financial aid is determined by a simple formula that subtracts a student’s expected family contribution (EFC) from a college’s total cost of admission (Cost of Attendance – EFC = Financial Need). If your EFC is less than then cost of attendance – including tuition, fees, room & board, books, travel and personal expenses – then the student qualifies for aid.

The EFC measures what a family should be able to pay for one year of college, based on income, assets, household size, and number of children attending college. If you have AGI of about $90,000 or higher, the EFC formula requires you to contribute 47% of your net income.

One silver lining of the sky-rocketing costs of education are that as cost of attendance increases, families with a higher EFC can still qualify for aid.   Remember that Financial Need = Cost of Attendance – EFC. Surprisingly, with the most expensive colleges now charging over $65,000 a year, parents who earn over $200,000 may still qualify. Here’s how: under the formula, the EFC is for the total family contribution, not per child. Even with an EFC as high as $100,000 (from income of about $200,000), after a 50/50 split the EFC is $50,000 for each child, less than the average cost of many elite schools.

Myth #2: Our assets disqualify us from aid

Surprised to learn you might still quality for aid with a six-figure salary, you now rightly ask: what about my assets? In fact, major sources of parent assets are sheltered from the EFC. Retirement assets such as 401(k)s and IRAs are not included, and neither is home equity (home equity is included in the College Scholarship Service Profile (CSS), a separate, FAFSA-like formula used by several schools).

Your reportable assets include cash savings, 529 plans, and any investments not in retirement accounts. This number is then reduced by a savings allowance based on age, up to a maximum of $30,000 for parents who are close to retirement. Finally, 5.64% of reportable assets are added to the EFC. Based on the FAFSA formula, a parent with a $1,000,000 IRA and $100,000 in cash and taxable investments would be expected to contribute less than $5,000 of assets.

Assets owned by the student are also considered for the EFC, and they are treated less favorably. Students do not get a savings allowance, and they are expected to contribute 20% of reportable assets. Notably, 529 plans and Coverdell IRAs are considered parents’ assets and get the favorable treatment (savings allowance + 5.64% contribution) even though they are owned by the student.

Myth #3: It doesn’t matter who owns the 529 plan

529 plans are considered a parent’s assets for FAFSA purposes, regardless if they are owned by a child or a parent. But what about generous grandparents? After all, grandparents who want to help fund college can also reduce their estate tax liability by gifting into a college savings plan. They can contribute up to $14,000 a year (or five years’ worth, $70,000, in the first year) into a child’s 529 plan with no gift tax consequences. Yet be warned, if not done carefully this can adversely impact the grandchild’s ability to qualify for aid.

Grandparent-owned 529 plans are not counted as assets for the EFC. Yet when it’s time to pay tuition, anything taken from the plan is treated as income to the student! This is a big negative for a student trying to qualify for financial aid.

Fortunately, new rules for the 2016-17 academic year and beyond have helped ease this quandary. The new rules shift which tax years are relevant when looking at income for financial aid. Income from the prior-prior year is what is now considered; for those applying for aid for the 2018-19 year, it is 2016 income that gets measured (previously income from the preceding year was relevant). This means that grandparent 529’s can bypass aid formulas entirely, but only if they are liquidated during the student’s last two years of college, or graduate school, where it will have no impact on income based on the prior-prior year lookbacks.

Myth #4 Those who don’t qualify have no good options

Smart college funding strategies can still save parents money even if they do earn too much to qualify for aid. To do so, high-earning parents need to shift their focus from financial aid to tax savings. Remember, the elite-school tuition isn’t just $65,000 a year, it’s $65,000 after-tax. For those in the 33% bracket, for example, this means the real annual cost would be $97,000!

Fortunately, there are strategies that can reduce the cost of college bill by minimizing the tax bill, often dubbed as tax-aid, or giving yourself a tax-scholarship. Shifting assets into a child’s name before being liquidated can be a very effective way to reduce taxes. Consider gifting appreciated assets to a child to be sold at their capital gains rate (potentially 0%) as opposed to your own (as high as 23.9%). Children who are kept off their parent’s return and deemed to be supporting themselves can also qualify for the American Opportunity Tax Credit, up to $2,500 per year for those with income below $180,000. In some situations, it is possible to save $5-10,000 in taxes per year for high-earners using the right tax savings techniques.

Perritt Capital Management, Inc. is the Registered Investment Advisor for Windgate Wealth Management accounts.  Windgate does not provide tax advice. Consult your professional tax advisor for questions concerning your personal tax or financial situation.

Data here is obtained from what are considered reliable sources; however, its accuracy, completeness, or reliability cannot be guaranteed.

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