Citi Personal Wealth Management
College financial aid is a source of great hope.
Parents imagine that their child will receive substantial money toward college costs. Frequently, they're shocked at how much the family is expected to contribute, how modest the aid package is—and how it includes hefty amounts of student loans, not the prized grant money they were hoping for.
The problem starts with four key misconceptions:
1. Types of Aid
Parents talk about financial aid as though it's a single pot of money. In fact, there are two key sources of aid, the federal government and the colleges themselves.
The federal government distributes a fair amount of grant money each year, mostly to lower-income families. The bulk of government aid takes the form of subsidized and unsubsidized loans. Colleges, meanwhile, also award significant amounts of grant money, though not as much as the federal government.
2. The Financial Aid Formula
Parents often talk about the financial-aid formula, as though there was a single way to compute how much aid a family is eligible for. There are actually two formulas, one used by the federal government and one used by many colleges—and even colleges vary in the precise formula they use.
Result: Strategies that can increase federal-aid eligibility, such as pouring money into your home, may not help under the college formula.
3. Aid Eligibility
People sometimes view aid eligibility as an all-or-nothing proposition. But in truth, a slight change in your finances won't cause you to go from receiving nothing in aid to suddenly being eligible for a large sum. By rearranging your finances, you might qualify for marginally more financial aid, but the impact may be modest.
4. Financial Aid and Scholarships
While your children could receive scholarships based on athletic or academic merit, the financial assistance they receive is more likely to be based on need. That doesn't mean a college aid officer won't craft a more attractive aid package for a student the school really wants. If there is no demonstrated financial need, your family may not get any aid, no matter how impressive your children's SATs are.
Financial aid awards are built around the concept of Expected Family Contributions or EFC, which is how much colleges and the federal government think you can afford to pay each year based on your income, assets and other factors.
Colleges will take their school's annual cost and compare it to your EFC. The difference between the two numbers determines how much aid your family receives. The aid package will consist of some mix of grant money, loans and work study. Clearly, the more grant money that's included, the more attractive the aid package will be.
What determines a family's EFC? The parents’ income is typically the biggest factor. That doesn't mean you should ask your boss for a pay cut so you qualify for more aid. The extra aid you receive won't compensate for the lost income—and, in any case, the additional aid may turn out be loans, rather than the grant money you were hoping for.
The aid formulas also assess the parents’ assets and the student's income and assets. The assessment of the student's income and assets is often at a steep rate. That means putting savings in a child's name can be a big mistake.
Much confusion centers on which parental assets are counted. For instance, under the federal formula, real estate isn't among the assets considered when determining aid eligibility. Problem is, real estate is looked at by some private colleges, so buying a bigger home may not help your family's aid eligibility.
Aid eligibility, however, can receive a significant boost if you have more than one family member in college at the same time. To get a better handle on what goes into the calculations and how much aid you might be eligible for, try the EFC calculator at www.collegeboard.com.
While there's a limit to what you can do to improve aid eligibility, you also don't want to do anything that damages your chances. On that score, here are four points to consider:
1. Be Cautious With Custodial Accounts:
Before the late 1990s, parents often plunked college savings in custodial accounts, which can be set up under a state's Uniform Transfers to Minors Act or Uniform Gifts to Minors Act. These accounts enjoy a modest tax break. Problem is, these accounts are generally considered a child's asset, which means they, might damage a family's aid chances. By contrast, education savings accounts are typically considered the parents' asset, so the impact on aid is more limited. Please note that the advantages and disadvantages of 529 plan accounts vary by state and should be carefully reviewed.
2. Consider the Timing of Cash Purchases:
Suppose you have money set aside for a big purchase, such as a kitchen remodeling or a new car. Alternatively, let's say you have large credit-card balances or auto loans outstanding. Before you file for financial aid, you may want to make your big purchase or pay down your consumer debt, so you have less cash to report.
3. Understand the Impact of Tapping Retirement Accounts:
Drawing loans or taking a withdrawal from retirement accounts to pay for college should be carefully reviewed as far as potential negative impacts to your retirement plan. It may impact financial aid eligibility – particularly during the calendar year that encompasses the second half of your child's junior year at high school, the first part of his or her senior year, and the three years that follow since financial aid eligibility will be based on income during this time period.
4. Think Through Capital Gains.
You might consider not selling investments with big unrealized capital gains during this same four-year period.
