Q: “Is there any way I can ‘beat’ the FAFSA? Is there a smart way to organize my money so we can take advantage of the most federal aid that we can?” – Paula, Philadelphia
A: There are several approaches to maximizing your eligibility for federal student aid. But before you start manipulating your finances, play a few what-if games with an expected family contribution (EFC) calculator such as the one on FinAid.org to evaluate the trade-offs of each strategy. The EFC determines a student's aid eligibility so if a scenario has only a minimal impact on the EFC, it's not worth pursuing.
The federal need analysis formula is heavily weighted toward income, so manipulating your assets often has little or no effect on it. For example, unsecured debt is ignored by the federal need analysis formula, so paying off debt can reduce the assets reported on the Free Application for Federal Student Aid (FAFSA), but less than 4% of dependent students get any contribution from parent assets, so reducing those assets by paying off debt might not improve aid eligibility by much.
Every $10,000 increase in income reduces financial aid by about $2,000-$3,000, while every $10,000 increase in assets reduces financial aid by about $250. (Still, it is worthwhile to pay down debt from a financial planning perspective, since paying off a high interest credit card balance with money from a low interest savings account will save money by reducing your net interest expenses.)
The federal need analysis formula has important thresholds at $50,000 and $31,000 of income. When total income is less than $50,000 and the parents were eligible to file an IRS Form 1040A or 1040EZ (or satisfy certain other criteria), assets are disregarded entirely. This is known as the simplified needs test. If income is under $31,000 and the same criteria apply, the EFC is automatically zero. If you can control your income and live off of savings, you might be able to increase your eligibility for federal grants by artificially reducing your income.
For example, if you own a small business that is incorporated as a non-pass-through entity, such as a C corporation, you can reduce your income to increase student aid eligibility. The income is retained by the corporation, increasing the net worth of the corporation, but this doesn’t matter for need analysis purposes, since the simplified needs test and/or the small business exclusion cause the corporation’s value to be ignored on the FAFSA. This approach does increase your tax bill, however, perhaps by enough to wipe out the financial benefit from an increase in aid eligibility.
Saving money in the parent’s name instead of the child’s can increase the amount of need-based aid the student can receive. If you made the mistake of saving in the child’s name, the simplest solution is to move the child’s money into a custodial 529 college savings plan. This 529 plan will be reported as a parent asset on the FAFSA, even though the student is the account owner. Parent assets are assessed much more favorably than student assets.
Increasing the number of children enrolled in college at the same time can have a big impact on each child’s eligibility for federal student aid, since they more or less split the parent contribution portion of the EFC. It is better to have twins than to have singletons who don’t overlap in college.
You should know that certain types of assets are sheltered from the federal need analysis formula. These include qualified retirement plans, the family’s principal place of residence, small businesses owned and controlled by the family, and life insurance. These might be a good place to move some of your money into. But shifting assets to a whole life insurance policy usually hurts more than it helps. Not only do such policies have an inferior rate of return, but any distributions from such a policy will count as untaxed income to the beneficiary. Moreover, most families who might consider such a strategy often have an income that is high enough on its own to eliminate eligibility for need-based grants.
Also, don’t forget to maximize the Hope Scholarship tax credit. The Hope Scholarship tax credit provides up to $2,500 in tax credits each year based on expenses of up to $4,000 for tuition, fees and course materials. You can pay for the expenses using loans and cash, but you can’t use the same expenses to justify both the tax credit and a tax-free distribution from a 529 college savings plan.
But whatever you do, don’t lie on the FAFSA. The Department of Education is starting to use a more targeted verification system to help identify errors on the FAFSA, and college financial aid administrators have a lot more experience detecting discrepancies than you have in falsifying the FAFSA. When you are caught you may face up to five years of jail time, a fine of up to $20,000 and disgorgement of all aid.
—Mark Kantrowitz is president of MK Consulting Inc. and publisher of theFinAid.org and FastWeb.com. He has testified before Congress about student aid on several occasions and is on the editorial board of the Council on Law in Higher Education.
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