If your high school student is college-bound, you’ve probably heard the term FAFSA. If not, you’re about to become quite familiar with it. FAFSA (Free Application for Federal Student Aid) is how the government determines a family’s eligibility for grants, work-study, loans and other forms of student aid to pay for college. The FAFSA determines how much a family is expected to pay, or the expected family contribution (EFC).
The FAFSA process can be daunting, but consulting a financial advisor can help alleviate the stress and perhaps save you money. This article discusses why everyone should fill out the FAFSA, how it looks at income level and student assets, the filing timeline, plus how you can increase your chances of receiving more grants, federal student aid, and other forms of student aid.
No matter your family’s adjusted gross income (AGI), you should fill out the FAFSA. In addition to determining your EFC, the form is required by some financial aid programs and scholarships, even if the award is not based on income level. Completing the FAFSA also tells colleges you’re ready, since many don’t want to grant an admission to someone who may delay for a year. Most students qualify for some form of grants, loans, work/study or other financial aid. Filing the FAFSA also makes students eligible for Federal Direct Student Loans, and helps parents qualify for Federal Plus loans, which offer the most advantageous terms.
The FAFSA timeline begins two years before your expected start date; it’s when your income is first included to determine your EFC. In October of the year prior to starting college, the window opens to fill out your FAFSA. First, be sure to register for your FSA ID from the department of education. The window doesn’t close until the June after your first year of college, but we recommend filling out the FAFSA early. Schools and states have a limited amount of student aid available, and some of that student aid is awarded on a first-come, first-served basis. Colleges use the FAFSA to determine your financial aid award letter, which will help you compare school costs during the selection process. You want to make sure you can lower your EFC, if possible.
Income level is a big part of figuring out your net expected family contribution. The FAFSA considers student income and parent income at different levels. For the FAFSA, income is reported for the year two years prior to the school year for which you’re requesting financial aid. (For example, if you’re applying for aid for the 2021-2022 school year, you need to submit your 2019 tax return). The FAFSA uses your adjusted gross income from the relevant tax reporting year as a starting point. Certain types of income are excluded from the FAFSA calculation, such as combat pay, tax deductions for education credits, and child support. You should ask your financial advisor any questions regarding which income to include on your FAFSA. There is also an income protection allowance that is not counted for the FAFSA. For students entering college in 2021, the income protection allowance for 2019 income is $6,970. Fifty cents of every dollar earned over the income protection allowance goes into the EFC. Remember, income after your sophomore year of college won’t be included as adjusted gross income since you shouldn’t need financial aid for your fifth year.
Pro tip: Any untaxed student income, like a gift or money paid on their behalf by anyone other than custodial parents, counts towards their adjusted gross income and can quickly exceed the income protection allowance. Try to time these gifts after their sophomore year.
Parental income has the most significant effect on your EFC. The parent income allowance for the 2021 school year ranges from $18,580 - $39,430, depending on your family situation. A family of four with one student in college has a parent income allowance of $29,890. This is where it becomes tricky, as there is a sliding scale from 5% to 27% of the parents’ AGI that will be a part of the expected family contribution. Parents are expected to contribute between 25% and 50% of what is owed any given year. The parental contribution doesn’t change if they have several children in school; it’s expected to be split between the children, reducing college costs.
Pro Tip: Since capital gains and stock options count as income, try to avoid excess income until after the student’s sophomore year or try to take it three years before college starts. Consult with your financial advisor early to develop a plan to reduce income during the period counted for the FAFSA.
While student assets and parental assets make up a smaller portion of the EFC, they can significantly reduce the total amount of what a family is expected to pay. Unlike income, there is no previous time frame considered for assets. Assets, for FAFSA purposes, are counted as of the day you submit the FAFSA. You can move money a week before you file that will have an impact on the FAFSA. Assets are looked at differently depending upon whether the student or the parent owns them. Student assets increase the EFC by 20% of the total. Parents use a bracketed scale that goes up to 5.64% of their included asset value; however not all assets are reportable. Some common assets excluded from the FAFSA:
The 529 plan is a popular college savings tool. It has one of the more interesting relationships with the FAFSA. 529 savings plans can be owned by the parent, the student, or anyone else (i.e., a grandparent). The FAFSA views a self-owned 529 as a student asset, and since that means 20% would be included as EFC, let’s eliminate that and look at the pros and cons of the other two options. If a custodial parent owns the 529, then the 5% of the value will go towards the EFC, and distributions don’t count as student income. A non-custodial owned 529 isn’t included in the asset calculation. But the payments to the school from this account are treated as income to the student (50% towards EFC over the allowance). If you do have a non-custodial owned 529, discuss this with your financial advisor to find a way to minimize the effect on the FAFSA. Two popular methods are:
Another student asset that is frequently used is the UGMA/UTMA account, owned by the child and controlled by a custodian. The FAFSA considers the UGMA and UTMA student assets; therefore, 20% of the value will be added to the EFC. Since there is no asset allowance for the student, we recommend either transferring these student assets to a parent-owned 529 (reducing from 20% to 5.64%) or spending down the student assets. Using the assets in this account to purchase a car or computer for school (prior to filing the FAFSA) can increase aid eligibility.
Pro tip: If the student has income, consider putting this in a Roth IRA so it is protected from the FAFSA. It won’t be counted as both income and a student asset.
Also: This article is not responsible for your teenager's reaction when you inform them the money in their name must be spent first.
Parental assets make up to 5.64% of the EFC. This may seem like a low percentage compared with the other major factors affecting the calculation. But when you add up all of your reportable assets, it makes sense try to reduce this exposure. The current asset protection allowance is $9,400 for parents’ eligible assets, but it’s been reduced significantly and will eventually disappear entirely. Between your checking account, savings account, money market, and emergency fund alone, you can be looking at a couple thousand dollars a year. Here are some ways to help reduce the impact on your expected family contribution.
Paying down debt can help you in two ways: The FAFSA does not consider debt as an offset to assets unless that asset secures it. Using reportable assets to pay off consumer debt like credit cards, car loans, or prepaying your mortgage lowers the FAFSA’s reportable assets. This is especially good if you’re paying off credit cards, because you’ll pay less interest in the long run.
Pro tip: Be cautious of using investments to pay off debt because you may incur capital gains. Consult with your financial advisor on the pros and cons of using this strategy.
Consider the timing of bigger purchases. Remember, the FAFSA calculates assets as of the day you file. If you plan to a buy a car, replace a roof, do some landscaping, or pay off an outstanding loan, make that payment before the assets are reported. Another timing strategy is to file the FAFSA the day before you receive your paycheck; this is generally when your checking account is at its lowest balance during the month.
Increasing contributions to qualified retirement plans can transform reportable assets into non-reportable assets. Maximizing these contributions can significantly affect your reportable assets. Consult with your financial advisor to get an idea of your reportable income for the upcoming year. You can make your Roth IRA or traditional IRA contributions earlier in the year before you file. This is especially helpful if you’re self-employed or own your own business. If you plan to file the FAFSA in October, you have nine months of earnings for the year already in the books. You could make half your contribution based on your income, and it will decrease your EFC.
Pro tip: Keep in mind that this will not reduce your income for purposes of the FAFSA, but rather the asset side of the calculation.
We’ve provided a few strategies to help maximize eligibility for financial aid such as grants, federal student aid and federal direct student loans. Each can save some money heading into this costly endeavor; using them together can help amplify the savings. It’s important that you consult with your financial advisor on the ramifications of these money moves and how they affect your overall goals and financial plan. You can increase your chances of financial success by creating a plan based on your goals and unique situation—and review it frequently.
Author: Jason Graper, CFP® | Practice Manager | Allegheny Financial Group | May 2021
Allegheny Financial Group is a Registered Investment Advisor. Securities offered through Allegheny Investments, LTD, a registered Broker/Dealer. Member FINRA/SIPC.