As college-age students and their families prepare for another FAFSA filing season to start in October, you may be wondering if there’s anything you can do to increase your child’s chances of being offered financial aid. While a lot of what determines eligibility for aid is out of our control, there are some things you can do to maximize how much aid they can get, as long as you act in time.
Let’s take a look at some of the factors affecting eligibility:
Student Income
The biggest factor that affects what aid is offered to each student is their own income which reduces aid by about 50% of the income received (over a $9,400 allowance). Most students don’t have much income to report but be careful of taking money out of 529 plans that are not in the name of you or your child because withdrawals from plans owned by grandparents or other friends or relatives are counted as income to the child. Instead, they may want to wait and use that money for the last two years of school after the aid has already been awarded.
This is a good time to note that each school year’s aid is determined based on the prior-prior year’s tax information. In other words, for the class of 2025, tax year 2023 is what’s used for their freshman year aid calculation.
Parental Income
Parental eligible income reduces aid by 22-47%, with higher reductions typically for household incomes above $50k. It’s based largely on AGI although contributions to pre-tax retirement accounts and HSAs do get added back for the years used to calculate the Student Aid Index, formerly known as the Expected Family Contribution. In other words, maximizing 401k contributions during the years that the FAFSA uses to calculate financial aid will not help.
Many people don’t realize that this income also includes asset sales and withdrawals from retirement accounts, including return of basis Roth withdrawals. Try to take capital gains before your child’s sophomore year of high school or after their junior year of college or look for investments you can sell at a loss if you need to liquidate taxable accounts during college years. If you want to use an IRA for education expenses, use it for the last two years like a non-parental 529 plan.
If at all possible, try to defer work bonuses as well, and for small business owners whose business income flows through their personal tax return, these are good years to realize larger business expenses, if at all possible.
Student Assets
Assets in your child’s name can reduce financial aid by about 20%, meaning that for every $1,000 they have in an investment account, their aid offering goes down by $200. This is a downside of UGMA/UTMA accounts. One exception is for money in a custodial 529 or a Coverdell Education Savings account, which are considered to be parental assets. Therefore, moving UGMA/UTMA money out of the child’s name into one of those accounts can increase the amount of aid offered.
Besides, the earnings in those accounts become tax-free as long as they are used for qualified education expenses, while liquidating custodial money will count as the child’s income, which we already know the aid calculation considers the highest available to pay for college. If you decide to keep assets in the child’s name, spending it as early as possible during the college years will at least help in later years when applying for aid.
Parental Assets
The good news is that investment accounts and other assets in the parents’ names will only reduce the amount of aid offered by about 5-6% of the value of the investment(s). 529 College Savings Plans, Coverdell ESAs, iBonds and taxable brokerage accounts fall in this category.
More good news: retirement accounts don’t count but debt also won’t reduce the countable assets, which is just one more reason to prioritize retirement account contributions, at least in the earlier years leading up to your application for aid.
School choice matters as well
While these are the factors that affect federal financial aid offered at all eligible institutions in the US, keep in mind that individual colleges may have additional aid and formulas that could enhance what’s offered at the federal level. Many schools that offer additional need-based aid will hand it out on a first-come, first-served basis, using the FAFSA as their tool to determine eligibility.
While a lot of students are undecided when the first FAFSA is filled out for their freshman year, once your child has chosen a school, it’s best to prioritize completing the subsequent years’ FAFSA as early as possible to ensure maximum aid eligibility through their school.
For more on the FAFSA and to get started filing, visit studentaid.gov, which is full of helpful explainers and resources.
For help with determining how to best fund your child’s education expenses that aren’t covered by financial aid sources, reach out to us. We can help you create a long-term plan that will optimize your overall financial plan so that you can take care of your kids and your future in a tax-efficient manner.