Paying for College: Financial Aid 101

September 2022 Update: The FAFSA Simplification Act—passed in December 2020 and scheduled to be rolled out over the next two years—introduces changes that will impact some of the advice offered here. Read about the coming changes in our article FAFSA Changes Are on the Way. Of special note is the change in how funds received from grandparents or a grandparent-owned 529 plan will be treated on the FAFSA.

“Will I qualify for financial aid or grants given my household income and assets?”

This is a common question. Before reading this long article you might want a short answer. Try this:

The Expected Family Contribution (EFC) for parents earning $220,000 with no taxable assets is $59,400 per year. So, one would be unlikely to receive much federal aid with earnings of this amount or higher. Similarly, for parents earning $175,000 with non-retirement financial assets of $200,000, the EFC is $55,000. This doesn’t mean that there wouldn’t be state or institutional need-based aid, or merit-based aid available. It’s always good to check the resources of the school and your state, as special programs do apply and can be very generous. But, at the income/asset levels described in the above examples, the information in this article will be less valuable to you.

The unknown of potential financial aid has many of us confused and without a good place to start. Could there be financial aid from federal, state, institutional, or private offerings? Does the student’s family earn too much to qualify? Is the aid need-based or merit-based? Is it in the form of loans, grants, scholarships, or work study? Can one be penalized for saving too much for college? These are just a few questions one might have. And, even if you find the answers and know all the current options and rules, they may change by the time the student arrives at their school of choice. No wonder many of us fear making the wrong choice. Hopefully this information will help!

Merit-based Aid: As the name implies, this aid is earned by the student based on academic, athletic or other achievements. Merit-based aid depends on the student, the institution or other private offerings and is very difficult to plan for in advance. But, if your child qualifies for it, it can be significant. It never hurts to investigate options at specific schools, civic clubs, churches and other private organizations and apply. For all types of aid, the earlier a student investigates and applies, the better!

Need-based Aid: There are some resources that help you determine need-based aid. Schools that offer federal need-based aid will ask the student and their family to fill out the FAFSA, or Free Application for Federal Student Aid, each year beginning in October of the preceding school year. This application determines the amount of the Expected Family Contribution. The difference between the school’s cost of attendance and the EFC creates a potential need, of which a portion may be met via aid from a federal package. This federal package may include financial aid, loans, and work study programs. The aid offered could all be in the form of loans. Many schools and most state aid agencies also use information from the FAFSA to determine eligibility for their programs. Here is an example of the calculation:

1. Cost of Attendance (COA) = $35,000
2. Subtract the Expected Family Contribution (EFC) = $25,000, as calculated by the FASFA
3. Financial Need of $10,000, which may be offered in the form of loans, grants, or work-study funds

Many private schools and some public schools (UNC, UVA, Duke, Wake Forest, and Davidson are among them) also use the CSS Profile, in addition to the FAFSA, to determine eligibility for awards from the institution. Each school can add unique questions to the CSS form, so it’s difficult to know how various assets and income might affect the aid at a specific school. Because of this, we will focus on the FAFSA in this article.

The FAFSA primarily collects information about various assets and income types. The assets or income are assessed at certain rates. The assessment amount increases the EFC, thereby decreasing the amount of the financial need. Here is a high-level overview of how certain assets or income affect the FAFSA application:

Assets
When the FAFSA asks for asset values, it asks for the current value “as of today,” or the day you are filling out the application. So, if you are completing your FAFSA for the 2019-2020 school year in January of 2019, you are using the asset value as of January 2019. The following are examples of how certain assets affect potential aid:

• 529 Plans owned by a Parent: The account balance is assessed on a sliding scale up to 5.64% of the balance, after certain allowances. But, distributions taken from the parent-owned 529 Plan are not included as income to the student or parent.
  • Example: A $100,000 balance in a parent-owned 529 Plan might decrease the financial need by $5,640 in the first year.
• Parent owned non-retirement accounts (bank accounts, individual or joint investment accounts, etc.) are assessed a sliding scale of 2.6%-5.64% of the balance.
• Parent’s retirement plan balances are not included on the FAFSA.
• 529 Plans owned by a Grandparent: The account balance is not assessed on the FAFSA application. But, once the funds are distributed to pay for college, the distribution amount will count as student unearned income on the next applicable FAFSA application. See the income section below for an example.
• UTMA/UGMA custodial account: This is considered a student’s asset and is assessed at 20% of the account balance.
  • Example: A $100,000 UTMA balance might decrease the financial need by $20,000 per year.
• Trust for which the student is a beneficiary: Most trusts have to be reported as a student’s asset on the FAFSA. See How Do Trust Funds Affect Financial Aid for College? from Saving For College to learn more.

Income
When the FAFSA asks for earned or unearned income, they are asking for the “prior, prior” year. This sounds confusing, but really just means you’re reporting income from your most recently-completed federal income tax return. So, if you are completing your FAFSA for the 2019-2020 school year, you are reporting income from the 2017 tax return or 2017 tax year. See the instructions for the FAFSA for guidance.

• Parent’s income is assessed at 22%-47%, based on sliding scale and after certain allowances.
• Parent’s retirement plan balances are not included as an asset on the FAFSA. But, if distributions are taken, they are considered income to the parent.
  • Example: A $25,000 withdrawal from a Roth IRA in fall of freshman year might decrease the financial need by as much as $11,750 in the student’s junior year.
• The FAFSA includes money received by the student or paid on their behalf as student unearned income. Student earned or unearned income is assessed at the rate of 50% (after certain allowances). This includes gifts or tuition paid directly from grandparents or from grandparent-owned 529 plans.
  • Example: A $25,000 distribution from a grandparent-owned 529 Plan in the fall of freshman year might decrease the financial need by $12,500 in the student’s junior year.

A few notable comparisons from the FAFSA to the CSS Profile:

• Equity in the parent’s home is not counted as an asset on FAFSA, but is counted on the CSS.
• Equity in the parent’s second home is counted as an asset on the FAFSA and CSS.
• The CSS Profile asks for all 529 Plans for which the student is a beneficiary, regardless of whether the owner is the parent or grandparent or someone else.
• While the FAFSA only requires the financial information of the custodial parent in the event of a divorce, the CSS Profile often asks for information on both parents.
• Retirement plans are included as an asset on CSS.

The following links take you to great tools if you would like to tinker with various impact and pros/cons of account types, balances, and income types:

• Saving for College: Financial Aid Calculator
• Saving for College: Compare Savings Options

Let’s calculate the potential decrease to financial aid resulting from the following 3 scenarios over a four-year period. This assumes a $100,000 beginning account balance and spending $25,000 annually from the account over the four years:

Based on the above options, 529 Plans owned by the parent impact financial aid the least, if you consider how each is counted as an asset and income once distributed. But, please don’t panic if you are a grandparent and you own 529 Plans for your grandchildren! As noted above, the difference is not as drastic as one would think because of the timing of when income is picked up on the FAFSA. And, there are options, which may include:

• Wait until your grandchild files their first FAFSA and CSS Profile. See what aid they are granted. Even if they qualify for aid, a hefty portion might be in the form of loans. If this is the case, you might prefer to help them pay the expenses rather than have them incur the debt.
• If they do receive need-based aid (which you do not want to impact), the following are a few options as related to the FAFSA. The impact of these options on each school’s CSS profile would need to be considered as well:
  • Wait to pay expenses from the 529 Plan until after their FAFSA is filed for the junior year (the FAFSA is usually filed between January and March of their sophomore year). When they file their senior year FAFSA in winter of their junior year, your 529 distributions won’t be picked up as income yet. If they are on the 5-year plan, then you would want to wait an additional year before paying expenses from the grandparent-owned 529 Plan. And, if graduate school is on the horizon, then consider delaying another two years.
  • You can change the 529 Plan account owner to the parent, if permitted by the 529 Plan.
  • You can slowly transition or “roll over” a grandparent-owned 529 to a 529 in the parent’s name. Those who pay close attention to detail can even do so in a manner that the transition happens after each FAFSA is filed and monitor so that 529 balance is spent down to close to zero before the next FAFSA is filed. This keeps the parent-owned 529 balances low, while also avoiding showing a distribution from a grandparent-owned 529.
  • You can change the beneficiary to a younger grandchild or other relative if you’ve determined the 529 balance won’t be used for the named beneficiary or originally-intended grandchild.
• If they don’t receive need-based aid and it looks like this won’t change over the next four years, then you may decide to help with tuition from the 529 from the start. Please note that timing is important when making withdrawals from any 529 Plan, as the draws must be taken in the same calendar year that the school expense is paid for the draw to count as a “qualified” or tax-free withdrawal. Also, if the parents qualify for certain education tax credits, they may want to pay certain expenses out of pocket. Please see Mary Lou’s article for specifics about using a 529 Plan to pay for college.

Please keep in mind this article focused more on financial aid calculations as related to the FAFSA application, and did not address the various impact on the CSS profile. This article also did not explore the all of the income tax treatment, penalties, earnings limitations, contribution limits, or advantages of one savings vehicle over another. Information in this article also does not apply to 529 ABLE Plans, Coverdell Education Savings Accounts, or pre-paid college plans. As always, please reach out to schedule a meeting at Bragg to discuss your specific situation. We are happy to help!

This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.