If you have a dependent that is planning to use financial aid for college, you might want to consider meeting with a financial advisor to create a plan for your assets ahead of time. Financial aid is mostly awarded based on need, so your assets could hinder your dependent’s ability to need-based financial aid.
What is the FAFSA?
The Free Application for Federal Student Aid (FAFSA) is the form that assesses a student’s financial need for student loans. It is the foundation for virtually all college loans, grants, and scholarships that are awarded each year. The FAFSA examines the assets for both you and your dependent to determine what you are expected to contribute before financial aid is awarded. The FAFSA is available on October 1st the year before your dependent plans to attend college. Even if your dependent doesn’t plan on using student loans for college, they may be missing out on a grant they qualify for by not filling one out.
The need for financial aid is calculated by subtracting the expected family contribution from the cost of attendance. Cost of attendance is the sum of tuition, fees, room and board, books, supplies, living expenses, and transportation your dependent is likely to owe. The expected family contribution is based on your cash on hand, income (student and parent), and the net worth of your investments including real estate. While you are not required to pay this amount, the assets you have and where they are play a significant role in your dependent’s ability to get student aid. To keep things simple, the more you have, the less they are eligible for.
How to Position Your Assets
Maximizing your dependent’s access to financial aid requires both long-term and short-term planning. For the short-term, your financial assets are calculated on the day that you enter your information into the FAFSA. If you’re expecting a raise, make sure you fill out your FAFSA before it takes effect. Your retirement savings are not counted as assets so if you are sitting on a large amount of cash, you can do one of the following:
- Pay Off Debt
- Prepay bills
- Max out your retirement contribution
- Increase 401(k) contribution
For long-term planning, it is important to understand how assets that you and your dependent hold factor into financial aid calculations. The federal government assumes that 5.6% of your assets and 20% of your dependent’s assets are available to go towards their college education. For this reason, it might make more sense to hold assets in your name instead of your child’s name. While you’d likely have to pay more towards taxes upfront, it would be significantly less than what the government would expect to go towards your dependent’s college education.
What is a 529 Plan?
A 529 is another long-term financial tool for college expenses. The 529 is a tax-advantaged investment plan created to encourage saving for future higher education. The main benefit of the 529 is that if the funds are used for qualified college expenses, the growth of the fund can be withdrawn tax-free. Qualified college expenses are generally anything required to attend such as tuition, rooms and board, supplies, and even a laptop computer. Every state sponsors at least one and often provides an additional incentive to contribute. For example, Iowa allowed account owners to take a $3,474 state tax deduction per beneficiary in 2021. To maximize the benefit, two parents would each have a 529 for every child they have and contribute at least $3,474 to each account. To receive the tax benefits, parents should have the account in their name, not their dependents. If your child chooses not to attend college or if you need to withdraw from your 529, the withdrawal will be taxed at your normal rate plus a 10% penalty.
Why Work with a Financial Advisor?
A college education is a significant investment in your dependent’s future. Your financial advisor should already have a good understanding of your assets and be able to help you position them to allow your child the best opportunity to meet their financial needs for college. That knowledge of your assets is important when filling out the FAFSA. If filled out incorrectly, your dependent may not qualify for any aid. Most importantly, financial aid policy is constantly changing. By the time you finish reading this sentence, Congress could have passed a new law that could change your savings strategy completely.
Boelman Shaw provides tax and financial planning services to help our clients get the most from their money. Subscribe to our blog for regular updates on our latest articles.