There are several strategies that students can use to increase their eligibility for need-based financial aid for college. These strategies are based on the income, assets and demographics of the student and parents.
A matter of timing
The Free Application for Federal Student Aid (FAFSA) bases the expected family contribution (EFC) on income and tax data during the prior-prior year, also known as the base year. The base year for the student’s first FAFSA runs from January 1 of the sophomore year in high school through December 31 of the junior year in high school.
Asset data, on the other hand, is reported as of the date the FAFSA is filed.
Accordingly, some strategies based on reducing income during the base year should occur well before the FAFSA is filed. Some financial moves may even need to be executed prior to the base year. For example, if the family needs to sell stocks and other investments to pay for college, they may wish to do so before the base year, so that the capital gains do not artificially increase income during the base year.
Similarly, if the family is paying down debt to reduce their reportable assets, they should do so before filing the FAFSA, so that their bank and brokerage account statements reflect lower account balances on the date they file the FAFSA.
It is also important to file the FAFSA as soon as possible on or after October 1, because some financial aid is awarded on a first-come, first-served basis until the money runs out. Students who file the FAFSA during the first three months generally get twice the grants, on average, of students who file the FAFSA later.
Strategies based on income
Reducing income during the base year can increase financial aid eligibility. Every $10,000 decrease in parent total income increases eligibility for need-based financial aid by about $3,000. Every $10,000 decrease in student total income increases eligibility for need-based financial aid by about $3,750.
Families should avoid realizing capital gains during the base year, or offset them with capital losses. Likewise, they should avoid exercising stock options and taking retirement plan distributions during the base year. Bonuses should be deferred until they no longer affect the expected family contribution (EFC). Otherwise, the higher income will yield less need-based financial aid.
Gifts from the grandparents to the student will count as untaxed income to the student. Gifts to the parents are ignored as income on the FAFSA. Grandparents should also consider contributing the money to a student- or parent-owned 529 plan.
There are certain income thresholds built into the federal financial aid formula. These include the Simplified Needs Test and the Auto-Zero EFC, which have current income thresholds at $50,000 and $26,000. (The Auto-Zero EFC income threshold will increase to $27,000 for 2021-2022.) It may be worthwhile to reduce parent income below these thresholds, since these simplified financial aid formulas can have a big impact on eligibility for need-based financial aid. For example, the Simplified Needs Test can cause all assets to be disregarded when calculating the EFC.
Strategies based on assets
Some strategies can shelter assets from the need analysis formulas. Other strategies shift assets from the student’s name to the parent’s name to reduce the impact of assets on the EFC.
Assets can be sheltered on the FAFSA by paying down debt. Money in a bank account counts against the EFC on the FAFSA, while many forms of consumer of consumer debt are ignored. So, paying down credit cards and auto loans reduces reportable assets on the FAFSA. It can also save money, if the interest rate paid on the debt is higher than the interest rate earned on savings.
Assets can also be sheltered by accelerating necessary expenses. If you were going to install a new roof on your home or replace the furnace, you might as well do it before you file the FAFSA instead of afterward. Like paying down debt, this reduces reportable assets on the FAFSA.
Increase contributions to qualified retirement plans in the years leading up to college. At the very least, maximize the employer match on contributions to your retirement plan. Even though voluntary contributions to a retirement plan will count as untaxed income on the FAFSA, the money already in a retirement plan is not reported as an asset on the FAFSA.
Note that qualified retirement plans, qualified annuities and the net worth of the family home should not be reported as assets on the FAFSA. Incorrectly reporting them as assets on the FAFSA is a common mistake. Small businesses with less than 100 employees that are owned and controlled by the family should also be excluded from assets on the FAFSA.
Some strategies depend on differences in the way student assets and parent assets are treated on financial aid application forms. Every $10,000 in reportable parent assets reduces eligibility for need-based aid by up to $564 on the FAFSA and $500 on the CSS PROFILE. Every $10,000 in reportable student assets reduces eligibility for need-based aid by $2,000 on the FAFSA and $2,500 on the CSS PROFILE.
These strategies shift assets from the student’s name to the parent’s name or spend down the student’s money first, to reduce the impact on eligibility for need-based financial aid. For example, one strategy moves money from an UGMA or UTMA account, which is reported as a student asset on the FAFSA, to a custodial 529 plan account. Although the student is the owner of a custodial 529 plan account, a custodial 529 plan account is reported as a parent asset on the FAFSA, yielding a more favorable financial aid treatment.
It is also important to avoid pitfalls involving assets.
- The Kiddie Tax may save money on taxes, but the increase in the student’s assets may eliminate eligibility for need-based financial aid. Student assets reduce aid eligibility by 20% of the asset value on the FAFSA, while parent assets reduce aid eligibility by at most 5.64% of the asset value.
- The proceeds of a loan, if unspent by the day the FAFSA is filed, will count as an asset on the FAFSA.
- Trust funds are not effective at sheltering assets, since trust funds must be reported as an asset even if access to the principal is restricted. Only certain court-ordered trust funds are ignored, such as a court-ordered trust to pay for future medical expenses of an accident victim.
- Cash value life insurance and whole life insurance may be sheltered as an asset on the FAFSA, but the return on investment is low and the costs are high, making them a lousy investment.
Strategies based on demographics
Changes in certain demographic variables may have a big impact on the student’s eligibility for need-based financial aid. These variables include the parent’s marital status, the number of children in college and the student’s dependency status.
If a dependent student’s parents are divorced or separated (including an informal separation) and the parents do not live together, only one parent’s information is required on the FAFSA. This parent, called the custodial parent, is usually the parent with whom the student lived the most during the 12 months ending on the FAFSA application date. If the custodial parent has remarried as of the FAFSA application date, the stepparent’s income and assets must be reported, regardless of any prenuptial agreements. If the custodial parent (and stepparent, if any) has lower income, it can yield an increase in need-based financial aid.
The parent contribution portion of the expected family contribution (EFC) is divided by the number of children enrolled in college on at least a half-time basis. Increasing the number of children enrolled in college at the same time can have a big impact on eligibility for need-based financial aid. Increasing the number of children in college from 1 to 2, for example, is like dividing the parent income in half. Note that the number of children in college can include a stepparent’s other children if the stepparent provides more than half their support, even if they don’t live with the stepparent.
A student’s dependency status determines whether the financial and demographic information of the student’s parents must be reported on the FAFSA. If the student is dependent, parent information is required. If the student is independent, parent information is not required, but information from the student’s spouse (if any) will be required.
Changing a student’s dependency status from dependent to independent can sometimes increase the student’s eligibility for need-based financial aid. The main ways a student’s dependency status is under the student’s control include delaying college until age 24, getting married, having a child or other dependents, serving on active duty with the U.S. Armed Forces or being a veteran of the U.S. Armed Forces. A college financial aid administrator can also override a student’s dependency status from dependent to independent when there are unusual circumstances, such as domestic violence and abandonment.
Strategies based on appealing for more financial aid
If a student’s ability to pay for college is affected by special circumstances, they should appeal for more financial aid. College financial aid administrators can make adjustments to the data elements on the FAFSA on a case-by-case basis, when the decision is supported by adequate documentation of the special circumstances.
Special circumstances include anything that has changed or anything that distinguishes the family from the typical family. It can include unemployment, death or disability of a wage-earner, high unreimbursed medical or dental expenses, homelessness, disability-related expenses, private K-12 tuition, parents genuinely enrolled in college, unusually high child care or dependent care costs (including nursing home costs for an elderly parent) and the end of child support or Social Security benefit payments. Special circumstances can also include one-time events that are not reflective of ability to pay during the award year, such as an unusual bonus.