Last month’s column focused on college savings plans — the 529, Uniform Transfer to Minor’s Act and Uniform Gift to Minor’s Act accounts (also called custodial accounts), and Coverdell Education Savings Accounts — that parents, grandparents, and others can use to save for a child’s college education. The message was start saving when the child is young. That said, you still may be in a position where you and your child need additional financial aid when the time comes. Just know that even with savings, retirement accounts, and owning a home, you may still be eligible for financial aid.
Below are highlights of some of the factors that could enhance your financial aid eligibility.
Making sure your assets and those of your child are owned by the right person, at the right time, and withdrawn in the correct manner and the proper sequence can increase your financial aid grant. Strategies that can be implemented are too numerous to mention in this column. Planning ahead, consulting your tax advisor, and working with a financial advisor can decrease your chances of making a mistake and increase your financial aid potential.
When applying for aid, nearly all colleges require applicants to complete the Free Application for Federal Student Aid and provide federal tax returns. This information is used to calculate the Expected Family Contribution, an index number that colleges follow to determine how much financial aid you are eligible to receive. Depending on the asset values, and in whose name the assets are owned, can affect how much aid you receive. Although alternative application forms and requirements exist, this column will concentrate only on the Free Application for Federal Student Aid.
All non-retirement accounts, including bank accounts, CDs, stocks and bonds, 529 accounts, and even investment properties and certain small businesses, are included in Expected Family Contribution calculations. When making a calculation, assets owned by parents have a much lower impact on financial aid grants than assets owned by their children. In general, only 5.64 percent of the value of parent’s accounts is expected to be used towards college expenses, as opposed to 20 percent of a child’s assets. Here are some of the most common types of accounts and how they affect the calculation:
Custodial accounts
Custodial accounts are considered an asset of the child. Each year 20 percent of the values of these assets are counted towards the calculation. That is nearly four times more than if the money had been in other types of college savings accounts.
529 Plans and Education Savings Accounts
These accounts are considered assets of the parent, not the child. Each year only 5.64 percent of the value of these accounts is expected to be used for college expenses. Withdrawals made from 529 accounts to pay for college are not included in the calculation and affect following year’s financial aid. That is why these plans have become so popular.
The 529 accounts owned by grandparents are not considered when determining the calculation. However, if a grandparent withdraws money from the account to pay for college, it is considered a gift to the child. In these cases the full amount can decrease the next year’s financial aid grant by 50 percent of the amount withdrawn. For example, if grandma withdrew $10,000 from her granddaughter’s 529 account and used it to pay for college, the next year’s financial aid grant could be reduced by $5,000 (half of the amount withdrawn). Talking with an advisor about withdrawal strategies before making withdrawals from a grandparent’s 529 accounts can lead to increased financial aid grants.
Retirement assets
The value of 401k, 403b, IRA accounts (traditional and Roth), and most other retirement accounts are not included in the calculation. Sometimes people take loans from their retirement accounts to pay for college. Those loan withdrawals are not included in the calculation.
An important thing to remember is when withdrawals are taken from Roth IRA accounts when applying for financial aid: If certain conditions are met, you may be able to withdraw funds from a Roth IRA before retirement age without any tax or penalty. If you do withdraw funds from a Roth IRA, it will be considered untaxed income when calculating, and can affect the next year’s financial aid grant by 50 percent of the withdrawal amount.
Small businesses and investment properties
In most cases, the value of a family-owned business is not counted towards the calculation. However, if you own more than 50 percent of the business and have more than 100 full-time employees, the value of the business will be included in the calculation. Investment and rental properties you own do not receive the same exclusion as small businesses. The full value of these properties will be included in the calculation.
Life insurance and annuities
The cash value of your life insurance policy and annuities are not considered in this calculation. However, in certain circumstances not covered in this column, certain types of annuities may be considered when determining your financial aid eligibility.
This column is a brief overview of the complex financial aid system. Planning in advance and working with a knowledgeable financial advisor should help you achieve your goals.
Anthony N. Corrao is an independent advisor with Corrao Wealth Management. For more than 25 years, he has helped families with their financial goals by developing financial, educational, and retirement planning strategies. He can be found at www.corra
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