8 Strategies for Parents to Maximize College Financial Aid Eligibility
Maximizing college financial aid eligibility for your child can be overwhelming and difficult to navigate. From lowering your “assessable assets” to considering Roth IRAs for summer jobs, here are Planning to Wealth's eight effective college financial aid strategies for getting the most aid out of the FAFSA for your child.
1. Roll custodial accounts like UTMA/UTGA accounts into 529s. This will lower Effective Family Contribution (EFC), since custodial accounts are treated as student assets, while 529s are treated as parental assets. Student assets are included in the EFC formula at 20% to 25%, while parental assets are included at only 5.6%. For purposes of maximizing financial aid, you probably want to avoid custodial accounts altogether.
2. Spend down children’s assets for college expenses ahead of parental assets. Since children’s assets count against you more in the financial aid formula than parental assets, prioritize spending assets held in the children’s name first. You might want to spend some of these funds on college tutoring or computers ahead of the college financial assessment years.
3. Maximize saving in retirement accounts like 401ks and IRAs. Unlike money saved in your taxable brokerage accounts, money in your IRAs, 401ks and other qualified accounts isn't counted towards EFC.
4. Pay debt to reduce parent assets. Using cash to pay off credit card debt, car loans, or to pre-pay your mortgage debt lowers the FAFSA’s “assessable assets” and results in a lower Effective Family Contribution (EFC). Similarly, you might want to pre-pay large expenses, like a new car or computer, ahead of filing the FAFSA. Be careful of selling investments to pay off debt and lower assessable assets; this can backfire as capital gains will increase reported income.
5. Be skeptical of advice to convert liquid assets into annuity/insurance assets. Since annuity and insurance assets aren’t assessable assets under the FAFSA, some product providers and insurance agents recommend a college financial aid strategy of converting cash or brokerage assets into annuities and insurance assets. However, it’s possible these conversions could cost you more in fees than the 5.64% decrease in EFC. Moreover, converting liquid assets into illiquid assets without increasing the rate of return is seldom a good idea. You don't want to get into a situation where you've fundamentally changed your asset allocation and paid a large amount of fees to try and game the FAFSA, but then your child ends up not going to college anyways.
6. Consider Roth IRAs for summer jobs. If children are getting earned income through part-time employment and/or summer jobs, consider redirecting college savings from assessable assets like 529s to non-assessable Roth IRA assets. Roth IRAs are fantastic savings vehicles for college, regardless if they are opened by the parent or the child.
You'll have more investment options in the Roth IRA than a 529 account, and distributions from a Roth IRA used for Qualified Higher Education Expenses avoid the 10% early withdrawal penalty. Moreover, distributions from Roth IRAs are principal first, so you can withdraw the original contributions from the Roth IRA to pay for other expenses without subject to taxation or an early withdrawal penalty.
7. For parents going through a divorce, structure the divorce settlement with student aid in mind. For divorced parents, the FAFSA will only look at the financial information for the custodian parent, the parent that the child stays with for the majority of the year. To maximize financial aid parents might want to consider designating the lower income spouse as the custodial spouse, since only the custodial spouse’s income and assets are assessed by the FAFSA.
During divorce settlement negotiations, consider the custodial parent receiving non-assessable property (home) assets over assessable alimony income for financial aid purposes. Another financial aid strategy would be to consider delaying alimony until after FAFSA assessment years. Many divorce agreements set up educational trusts for the child’s education. This can be a mistake since the FAFSA will assess the trust as a student asset and potentially lower financial aid eligibility.
Also, for parents considering remarrying, they may want to consider delaying remarriage until after the FAFSA assessment years. The new spouse’s income and assets will become assessable by the FAFSA once the custodial spouse is remarried.
8. Coordinate grandparent college contributions. Encourage grandparents to redirect their gifts to college bound grandchildren to the parents of the college student, which avoids the gifts becoming assessable income of the student. The grandparents could also just deposit assets in a 529, which is assessed at a much lower rate than direct gifts, or buy non-cash items for the student's education like computers or airplane tickets.
Oftentimes, grandparents set up educational trusts for students. To maximize financial aid eligibility, it’s preferable to have the beneficiary of the trust be the parents instead of the student. Alternatively, grandparents can agree to pay down student loans after graduation.
Bonus Tip: Fill out and file the FAFSA early. The FAFSA opens on October 1st, which is three months earlier than it used to open. Since financial aid is first-come, first-serve, you increase your chances of maximizing college financial aid eligibility by filing early. Also, since the tax year submitted to the FAFSA is prior-prior year, your financial circumstances may have changed. Filing early gives you more time to inform the financial aid offices of any change in circumstances to potentially alter your award for the better.
David Flores Wilson, CFP®, CFA, CDFA®, CCFC is a New York City-based CERTIFIED FINANCIAL PLANNER™ Practitioner & Wealth Advisor at Watts Capital. He can be reached at email@example.com.