Do you know how your investments might reduce your chances for financial aid?
And what about the role that your family’s home equity plays in determining whether your child will receive financial help from a college?
When their children are little, parents often feel virtuous about saving for college, but when the college years are approaching, they often begin to view their college accounts and other investments as if they were time bombs with short fuses. Parents frequently assume that their assets will wreck their chances for financial aid.
But parental fears about their investments are usually worse than the reality behind the role that assets play in their financial aid determinations.
Whether your assets will hurt your financial aid prospects depends in part on what financial aid application(s) each school uses.
There are two main applications:
Free Application for Federal Student Aid (FAFSA)
All colleges and universities use the Free Application for Federal Student Aid (FAFSA) to determine if a student qualifies for federal and/or state financial aid.
Most schools also use FAFSA to decide if a student qualifies for financial help from their own institutions. Nearly all public institutions and many private colleges find it sufficient to rely solely on the FAFSA.
Roughly 229 colleges and universities (nearly all of them private) require families seeking financial aid to complete an additional aid application called the CSS Profile. Highly selective schools, such as the Ivy League, Stanford, MIT, and Amherst, use the CSS Profile.
Let’s first take a look at how assets fare under the FAFSA aid calculations.
Many families will be pleasantly surprised that with the FAFSA, their investments make little or no impact on their children’s chances for need-based help. That’s because FAFSA ignores some assets, including the two biggest for many families: home equity and qualified retirement accounts.
Here are the assets that FAFSA ignores and parents do not need to include in their application:
1. Equity in a primary home.
2. Qualified retirement assets, including:
The FAFSA directions aren’t as clear as they could be, so some families mistakenly include their retirement accounts, which, depending on their size, can kill their chance for financial aid.
While retirement accounts are safe, other assets are not. The following are those assets FAFSA does assess in determining eligibility for financial aid.
All taxable accounts including:
The FAFSA formula assesses relevant parent assets at a maximum of 5.64%. The federal formula assesses child assets, which would include all custodial accounts as well as a child’s own savings/checking, at 20%. The federal formula treats child assets more harshly because students are expected to contribute more of their money to pay for their college years.
Let’s look at a couple of examples on how the children’s versus the parents’ assets come into play when calculating financial aid.
In this example, the child’s assets ($50,400) are assessed at the FAFSA rate of 20%. The child’s eligibility for need based aid drops by $10,080, which is a significant hit.
For financial aid purposes, it’s better to have money held in the parents’ names rather than the child’s name. However, the child assets shouldn’t pose a problem if a family isn’t going to qualify for need-based aid because of high parental assets and income. Wealthy clients will want to look for schools that provide merit scholarships for high-income students, and luckily most do.
While this hypothetical couple has $552,000 in assets, the FAFSA formula would only consider a fraction of the investments when calculating aid eligibility:
ASSETS INCLUDED IN FAFSA FORMULA
To see what impact the above assets would have on aid eligibility, multiply the amount by 5.64%. It would appear that this family’s eligibility for financial aid would drop by $5,922, but the federal formula has one more step.
The financial aid hit in this hypothetical example ($5,922) would actually be lower because the FAFSA formula automatically shelters a portion of the parents’ nonretirement assets.
Just how much you can shield will depend on the age of the oldest parent as of the last day of the most recent calendar year. The closer the oldest parent is to retirement age, the more the family can shelter.
A couple in which the oldest parent is 50 years old, for instance, could shelter $12,500 in taxable assets based on the current formula.
The U.S. Department of Education releases the formula every year in its annual publication entitled “The EFC (Expected Family Contribution) Formula.” So not all of your taxable assets will hurt your aid chances.
FAFSA also allows parents with a low enough income to avoid divulging any of their assets through something called a “simplified means test.” If the parents’ adjusted gross income is less than $50,000 a year and the parents were eligible to file IRS Form 1040A or 1040 EZ, they should not include their assets on the FAFSA.
People who may qualify for a simplified means test could include a divorced parent who has considerable assets through a divorce, but who makes a modest salary. An unemployed client might also qualify.
Because the FAFSA formula only considers taxable and college assets when determining aid eligibility, the financial aid impact often won’t be as punitive as parents assume. In fact, it may not be an issue at all, so it’s always smart to save for college.
Schools that use the CSS Profile delve deeper into a family’s finances, so this aid application will include significantly more questions. In fact, schools that use the CSS Profile can select from hundreds of different supplemental questions.
You can find the list of CSS Profile institutions on the College Board’s website. If your children are aiming for prestigious private schools and seeking financial aid, they will be completing the CSS Profile.
What the CSS Profile ignores:
The CSS Profile does ask about the family’s retirement assets, but it’s considered rare for a school to use those assets in the aid calculations. However, the CSS Profile does consider the following assets:
The CSS Profile formula, which you will also see referred to as the institutional formula, assesses parent assets at 5% compared to the FAFSA’s maximum of 5.64%. The CSS Profile does not provide parents with an asset protection allowance.
The institutional formula assesses child assets, which would include all custodial accounts, at 25%.
The CSS Profile does require parents to share their estimated home equity on the aid application. What schools do with the home equity information will vary by institution, so at some schools, the chance of getting financial aid could plummet while at other institutions the odds wouldn’t be jeopardized even if a family were living in an exclusive zip code.
There are three ways that a CSS Profile school can assess home equity in its formula:
Suppose a family has $400,000 in home equity. This equity is treated the same as parental taxable investments and college accounts and assessed at 5%. In this example, eligibility for financial aid drops by $20,000. That’s a significant hit.
Some schools that assess home equity limit the pain by linking it to the family’s income. In some cases, the school may tie the home equity assessment to no more than two times the family’s income.
Say, for example, the family’s income is $60,000 with home equity of $400,000. The school would only use $120,000 ($60,000 x 2) of home equity in the aid calculation that assesses parent assets at 5%. The family’s eligibility for financial aid would only drop by $6,000 rather than $20,000.
The CSS Profile does not require parents to use a specific source when calculating home equity. Parents may want to look at the assessed property valuation from their local taxing authority, Zillow, other house comp websites, or recent sales in the neighborhood.
Ask potential schools how they handle home equity. It can be a financial aid deal breaker. Some schools that use the full value of home equity in calculating a student’s aid package say they will accept appeals from parents.
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This post was written by Lynn O’Shaughnessy and first distributed by Horsesmouth, LLC. Lynn O’Shaughnessy is a nationally recognized college expert, higher education journalist, consultant and speaker.
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