How To Go To College Without Going Broke

Basic Principles

There are several basic principles behind the strategies for maximizing eligibility for financial aid. These principles include:

1. Reducing income during the base years.
2. Reducing “included” assets. Converting included assets into nonincluded assets will increase eligibility by sheltering them from the need analysis process. However, most financial planners recommend that parents maintain a contingency fund equal to six months’ salary in relatively liquid form for emergencies and other unforeseeable circumstances.
3. Increasing the number of family members enrolled in college and pursuing a degree or certificate at the same time. The family contribution is split among all children who will be enrolled in college.
4. Taking advantage of the differences in the way the need analysis process assesses the assets and income of the student and his or her parents.
5. Changing the student’s status from dependent to independent. This is generally not very easy to do.

Income

If you estimate your income on the Free Application for Federal Student Aid (FAFSA), don’t overestimate. Families have a natural tendency to overstate income, in part by reporting gross income (before deductions for health insurance premiums) instead of adjusted gross income. Be careful when reporting the amount of taxes paid. Many people confuse the amount of withholding (the figure from the W2s) with the amount of taxes paid. Avoid incurring capital gains during the base year, which are treated as income. Sell stocks and bonds during the sophomore year in high school. If you must sell while your child is in college, wait until April of their junior year after the financial aid application has been filed. 

Do not take money out of your retirement fund to pay for educational expenses, which are sheltered from the need analysis process. If you withdraw too much money from your pension or withdraw them before the financial aid application is filed, you will have converted them into an included asset. 

In certain circumstances, a slight decrease in the parents’ income may yield a significant increase in eligibility for Federal financial aid. If both of the following are true: the parents’ adjusted gross income is under $50,000 and all family members are eligible to file an IRS Form 1040A or IRS Form 1040EZ income tax return or aren’t required to file.

So if the family has a substantial amount of assets and the parents’ income is close to $50,000, the parents should consider taking steps to reduce their income below the $50,000 threshold.

Some methods of reducing the parents’ income include:

• Taking an unpaid leave of absence.
• Incurring a capital loss by selling off bad investments.
• Postponing any bonuses until after the base year.
• If the family runs its own business, they can reduce the salaries of family members during the base year. The income retained by the corporation will still be considered a business or investment asset, but assets are treated more favorably than income.
• Making a larger contribution to retirement funds.

If both members of a married couple have earned income, but one falls below the income threshold for filing an income tax return and the other falls above the threshold, it may be beneficial for the member with income above the threshold to file as married filing separate. This will allow the other member to not file a return. This yields a lower AGI.

Assets

As a general rule, unless the family is completely certain that the child will not qualify for need-based aid, money should be saved in the parent’s name, not the child’s name. Putting assets in the child’s name has one major benefit and two major risks.The benefit is the tax savings due to the child’s lower tax bracket. The risks, however, often outweigh the benefits. Such a transfer of assets will result in a reduction in eligibility for financial aid, and the child is not obligated to spend the money on educational expenses.

After the child reaches the age of 18, a family can take advantage of tax savings by placing assets in the child’s name, because the income from the assets will be taxed in the child’s tax bracket. But the need analysis formulas assume that the child contributes a much greater portion of his or her assets (and income) than the parents, with the result that such tax-sheltering strategies often significantly reduce eligibility for financial aid. Parents should carefully consider the financial aid implications before transferring money into their child’s name. If parents want to transfer their child’s assets back to their name, they should do so before the base year.

The College Cost Reduction and Access Act of 2007 changed the treatment of custodial versions of qualified tuition accounts, like 529 college savings plans, prepaid tuition plans, and Coverdell education savings accounts. When they are owned by a dependent student, these plans are reported as parent assets on the Free Application for Federal Student Aid (FAFSA).

Specifically, for a custodial account to be counted as a parent asset instead of a student asset, all of the following must be true:

• The account must be a custodial account, meaning that the student is both the account owner and beneficiary.
• Only 529 College Savings Plans, Prepaid Tuition Plans, and Coverdell Education Savings Accounts qualify.
• The student must be a dependent student.

This provides an additional way for a parent who saved in the child’s name to undo the damage. Before filing the FAFSA, the parent should convert the asset (by liquidating it, as contributions must be in cash) into the custodial version of a 529 college savings plan, prepaid tuition plan, or Coverdell ESA. The money will then be treated as a parent asset on the FAFSA even though it is still owned by the student.

So before you spend much effort trying to optimize the parents’ assets, use Finaid’s EFC calculator in detailed mode and see whether there is any contribution from parent assets.

Sheltering Assets

1. If your children have any hope of being eligible for financial aid, do not put any assets in your children’s names, regardless of the tax savings. Likewise, don’t pay your children a salary as part of the family business. On the other hand, if you are absolutely certain that your children will not qualify for financial aid, take advantage of all the tax breaks you can get.
2. Spend the student’s assets before you touch any of the parent’s assets.
3. The assets of other children are not considered by the need analysis formula. So putting parent assets in the name of a younger (or older) sibling can help shelter them from the need analysis. On the other hand, many schools now ask for the assets owned by the student’s siblings, so this strategy may affect the awarding of institutional funds.
4. Certain types of property, such as automobiles, computers, boats, furniture, appliances, books, clothing, and school supplies, do not count as assets. If you will need to make certain major purchases, such as buying a new car, do it by the base year so that your liquid assets are reduced.
5. If grandparents want to give money to the children to help them pay for their education, ask them to wait until the child graduates and then pay off the child’s student loans. If they can’t wait, have them give the money to the parents, not the children, so that the money is assessed at the parent’s rate in the needs analysis process.
6. Trust funds are generally ineffective at sheltering assets because they are assessed as a student asset. Moreover, if the fund is set up to prevent the trustees from spending the principal, it can harm the student’s eligibility for financial aid.
7. Retirement funds, pensions, tax-deferred annuities and life insurance policies are generally not considered assets by both the Federal Methodology and the Institutional Methodology need analysis formulas. You can shelter a considerable portion of your assets by making the maximum contributions to these funds in the years before the base year.
8. Small businesses that are owned and controlled by the family are excluded as assets on the FAFSA.
9. Real estate is normally treated as an investment asset, not a business asset, unless it is part of a formally recognized business that provides services beyond utilities and trash collection, such as maid service.
10. For institutional need analysis, do not overestimate the fair market value of your home. If you have a recently assessed valuation or appraisal or use Federal Housing Index Calculator to get a very conservative estimate of the current market value.

Loans

1. Avoid consumer debt, such as high credit card balances and car loans. Consumer debt isn’t counted in the need analysis formula, so there’s no benefit to having a credit card balance. Paying off your credit card balances and auto loans will reduce your available cash, thereby increasing your eligibility for financial aid.
2. The Federal need analysis methodology does not consider the equity in the family’s primary residence. So to maximize your eligibility for Federal aid, you could use your cash and other included assets to prepay part of your mortgage. Many private colleges and universities, however, do count your home as an asset when allocating institutional funds. If so, it may be worthwhile to get a home equity loan to provide funds for your children’s education. Not only are the interest payments tax-deductible, but the loan reduces your assets.
3. If you decide to get a home equity loan to help pay for your college expenses, get a home equity line of credit, not a loan. When you get a loan and don’t spend all of the money before you file the next financial aid form, you’ll have created an asset that shows up in the need analysis and you’re also paying interest on the full amount of the loan. With a line of credit, you borrow only the portion you actually use.
4. In most cases, the interest rate on educational loans is better than the interest rate on home equity loans. On the other hand, the interest payments on your mortgage are tax-deductible. Only a limited portion of the interest payments on student loans is deductible, and the deduction is subject to income phaseouts. All things considered, however, educational loans are usually the financially superior choice.

Number of Family Members in College

Many need analysis formulas to divide the parent contribution among all children in college. A family which doesn’t qualify for financial aid when one student is in school may suddenly qualify when two or more children are enrolled at the same time.

For example, suppose the need analysis formula calculates a parent contribution of $17,000 when one student is in school and a student contribution of $2,000. With college expenses of $19,000 a year, the student will have a financial need of $2,000 and will probably not be eligible for much financial aid. But next year, when the student’s sibling is also enrolled, the parent contribution is split in half. Even though the parent contribution has increased a little, to $18,000, each student is expected to receive $9,000 from their parents. With college expenses of $21,000 and a student contribution of $2,000, each student now has a financial need of $10,000 ($21,000 less an EFC of $11,000), and both will be eligible for some financial aid.

If you are a parent who is legitimately going back to school to finish your education or pick up an additional degree, provide documentation of this to the school’s financial aid administrator and ask for a professional judgment review. The school has the authority to deduct the parent’s actual education expenses from income or compensate in other ways. Since there has been a history of fraud in this area, you will have to convince the financial aid administrator that you are genuine.

Number of People in Household

A person counts as a member of the household if they get more than half their support from the student’s parents. The student is also counted, regardless of where the student gets his or her support.

1. If the student’s parents are divorced or separated, the custodial parent is
   responsible for filling out the financial aid form. The custodial parent is the parent with whom the student lived the most during the past year. This is not necessarily the same as the parent who provided more than half the student’s support or who claimed the student as a dependent on their tax return. It does not even have to be the parent who has legal custody of the child.
2. Unlike most questions on the financial aid application, which focus on the base year, the questions about the number of people in the household and the number of family members in college are concerned with the award year. So if the mother is pregnant the unborn child counts toward the household size but does not count toward an independent student status determination.

Dependency Status

The requirements for a student to be considered independent are rather strict. Only two are reasonably under the student’s control and those are:

• getting married before submitting the FAFSA
• delaying college until age 24

Either of these will qualify the student as independent for the awarding of federal funds. For the awarding of institutional funds, many schools adopt a stricter stance and require evidence that the student is strictly self-supporting. A student who lives at home with his or her parents (even if he or she pays rent) and doesn’t earn a modest income probably won’t qualify.

If a student gets married after filing the FAFSA, it will have no effect on the current year’s need analysis. You can’t change your dependency status mid-year by getting married. A mid-year change in marital status will affect dependency status only in subsequent years.

Independent student status does not always lead to an increase in eligibility for financial aid. Although it does mean that the parents’ finances are not considered by the need analysis process, a student who gets married will have to include the financial information for his or her spouse.

Financing College Costs

1. Ask whether the school has a tuition installment plan that allows you to spread the tuition payments over a 12-month period. Some schools do not charge any interest for their tuition installment plans and the up-front fees are usually low, so it may be worth participating.
2. Save for college. Even though the need analysis formula takes a bite out of any assets, the more you save for college the better off you’ll be. The more money you have, the more options you’ll have on how to pay for college. If you start early enough, saving a reasonable amount of money regularly can grow to a substantial college fund by the time your children reach college.
3. Apply for private sector scholarships. Fastweb is an excellent free resource for college scholarships.
4. Pursue college-controlled merit scholarships.

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