What to know before you fill out the FAFSA: Income and Asset Strategies

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The FAFSA, which stands for “Free Application for Federal Student Aid,” is a form that asks a series of questions about your family’s financial picture. This application helps the help-1468281_1280U.S. Department of Education calculate your Expected Family Contribution (“EFC”), which is the amount the federal government expects your family can contribute towards your child’s college each year. Colleges also use that “EFC” calculation to help determine the amount of financial aid that they may award, above your family’s Expected Family Contribution.

As you can probably imagine, accurately determining your family’s EFC is very important. All families that have a student who will be attending college during the next academic school year should complete the FAFSA. Although this may appear a daunting task, in line with the complexity of filling out your own income taxes, I often tell parents that filling it out is not really that difficult for most families. Filling the FAFSA out correctly, however, is often not that simple.

The FAFSA can be completed online at https://fafsa.ed.gov/. I think most families can usually complete it in under an hour, especially if you have in front of you the personal financial information that they will be asking about. Based on how you answer each question, the online form will guide you through the application, and automatically add or eliminate other questions, based on the information you provide.

Here’s where I think families make some of their biggest mistakes when planning for, and completing, the FAFSA:

  1. Not reading the questions: I see errors from families who answer questions incorrectly because they misread the question. For example, be careful that you do not enter parent data in the student section, and vice versa;

  2. Not knowing the intent of each question can lead to errors and potentially thousands of dollars in lost financial aid awards: For example, in a divorce situation, knowing which parent’s income to enter is very important, or when to enter a step-parents income;

  3. Not weighing income tax strategies vs college planning strategies: There are times when optimal financial aid strategies may mean sacrificing getting the maximum income tax deductions. I suggest that parents understand which strategy may give them the most economic benefit and plan accordingly, year by year;

  4. Not planning ahead of time to shelter income, but only when appropriate;

  5. Not taking advantage of sometimes simple, low-cost, asset sheltering opportunities. Like income sheltering strategies, assets sheltering strategies should only be used when appropriate;

  6. Not knowing how a tax refund may affect your EFC;

  7. Misunderstanding how retirement plan contributions may affect your EFC.

The areas above are where most family’s can concentrate and potentially make the biggest impact in lowering their their Expected Family Contribution. As you’ll notice, these areas directly relate back to either income or assets… which is the focus of the questions on the FAFSA.

In fact, the FAFSA calculation is determined by seven different factors when calculating your family’s EFC:

  1. Parent’s Income;

  2. Parent’s Assets;

  3. Student’s Income;

  4. Student’s Assets;

  5. Age of oldest parent;

  6. Number of family members in household;

  7. Number of students in the family attending college (generally this means children attending college; the rules are more complicated when a parent and child are both attending college in a given academic year);

The first four are the areas where many families can use strategies that may help lower their Expected Family Contribution. I’ll focus on those first four factors in this article. However, I have just a brief thought on #7 for young couples starting out and considering having kids. I sometimes hear from young families that they want to space their kids apart by about four years, so that they have one child out of college before the next one starts. However, with the way that financial aid formulas work, families will usually qualify for more financial aid with the more children they have in college. So, if you’re planning a family, spacing your children closer together may be more savvy as a college funding strategy!

Let’s get back to those first four factors and how they can have an effect on your Expected Family Contribution:

dollar-1443244_640Income

Recent changes to the FAFSA now use a family’s prior-prior year’s tax information. No, I didn’t stutter. You’re child’s financial aid for the next academic year will be based on the your taxes from two years ago. So if you child is entering college in the Fall of 2017, you’ll be using your 2015 federal income taxes to fill out the FAFSA. If they are graduating high school in 2018 (entering college in the Fall of 2018), you’ll be using 2016 federal income tax information, and so on. This means planning ahead is very important. If you’re looking to maximize income strategies that can help you potentially qualify for more financial aid, then you’ll need to be doing this type of planning no later than your child’s freshman or sophomore year of high school.

Parent Income and it’s potential effect on EFC:

Parental income is an important piece of the Expected Family Contribution calculation. Approximately 22-47% of a parent’s eligible income can be “assessed” and considered available for use towards your child’s college… whether or not that money is actually available! Parents are allowed an Income Protection Allowance (IPA) and under certain income levels, income and/or assets may not be counted at all. Strategies that may work in specific situations, include:

  • Deferring employment bonuses into a future year (or deciding to take it in a current year) to take advantage of the timing of your federal income taxes and the years you’ll be completing the FAFSA;

  • Deferring income into a future year (or deciding to take it in a current year) from employment and non-employment related sources;

  • Avoiding capital gains or actively neutralizing them to reduce income on the FAFSA. (For example, selling an investment may generate a capital gain for federal income tax purposes, but may be considered income for FAFSA purposes);

  • Optimizing tax withholding since tax refunds are considered “income” on the FAFSA;

  • Minimizing interest and dividends on tax years that will be used to calculate your EFC.

Student Income and it’s potential effect on EFC:

Generally, a student’s income does not play as big a part of the calculation as parent’s income. However, in some cases a student’s income, especially as their college education progresses, may be significant. Here are some considerations:

  • Work study vs non-work study jobs;

  • Working past the student “income protection allowance” earnings level may be counter-productive to receiving financial aid, but must be weighed against the potential for aid and the income being earned.

gold-163519_640Assets

Parent Assets and it’s potential effect on EFC:

Many parents are overwhelmed by the college planning process and how it suddenly pounces on them in their child’s junior and senior years of high school. So, it’s understandable that they are not aware of the many ways to help shelter their assets from the financial aid formulas. Here are some things to think about as you create a strategy:

  • Up to approximately 5.64% of parents’ assessable assets can be considered “available” for you to use towards your child’s college Cost of Attendance (COA). Lowering the assessable assets through low-cost, flexible, sheltering techniques may lower your Expected Family Contribution and increase the potential for greater financial aid awards;

  • Understand that on the FAFSA, your primary residence is not assessed, which is different than on the forms that some private colleges use, where home equity may be a factor;

  • Real estate other than your primary home is often considered an assessable asset on the FAFSA, but there are some strategic ways to significantly lower it’s impact;

  • Knowing how different loans may affect financial aid and structuring your debt to help potentially lower your EFC. The FAFSA normally does not care about how much you have in consumer debt, but there are limited ways to use some types of loans to help qualify for more financial aid;

  • Using strategies to convert “assessable” assets, like taxable accounts, into non-assessable assets;

  • Understanding the effect of retirement plan contributions on current year vs future year EFC calculations;

  • How 529 Plans are factored into the EFC calculation and who should own them (parents vs grandparents, for example);

  • When an annuity, life insurance or retirement account should be used to help shelter assets (this is especially an area where parents need to be very careful!)

  • Weighing tax consequences of sheltering strategies vs the benefit of sheltering

  • Knowing when a sheltering strategy may not provide much, if any, benefit or just adds an unnecessary cost and loss of flexibility to your financial situation.

Student Assets and it’s potential effect on EFC:

Your child’s assets are assessed at a much harsher rate than parent’s assets, as colleges look towards them as being much more available towards their Cost of Attendance. Here are somethings to make sure that you know:

  • Parent’s assets are assessed at 5.64% above their APA, vs student’s assets, which are assessed at 20% from

  • When to keep the assets in a child’s name vs when to shift it to a parent;

  • When you should never shift the asset from a child to a parent!

  • How gifts to your child (cash, direct tuition payments, non-parent owned 529 Plans, etc) can effect the financial aid formulas (and college aid directly!).

I mentioned at the beginning of this article that filling out the FAFSA is not really that difficult. This is true, and the online version at https://www.fafsa.ed.gov leads you through the application very efficiently. However, filling out the FAFSA correctly, and knowing which strategies may lower your Expected Family Contribution, is not as easy! By carefully evaluating the income and assets of both parents and students, and using the right strategies for your family situation, you can potentially have a significant impact on the amount of money that colleges award in financial aid. Although I’ve tried to provide you with important points that many families should consider, it is impossible within the scope of this article to go into great detail or cover every consideration. This is especially true since each family’s financial “picture” is different and strategies should be customized to their specific situation.

If you have any questions, please feel free to email me at questions.answered@rockcrestfinancial.com. If you feel like you would like to talk in person, by phone, or via a one-on-one web meeting, you can schedule a free 60-minute consultation at https://www.cloudhq.net/meeting/steven.boorstein@rockcrestfinancial.com