College cost and affordability. Part 1.

This time of year can be very busy for high school senior students and their parents.  With college application deadlines looming, the thought of how a family can afford the cost of a particular college is at the back of many minds.  We will post a series of questions regarding how to make college affordable, including financial aid eligibility.

Good luck to everyone with the applications.  We hope your child lands in the school which is a great fit for the next four years.

How does the federal financial aid process work?

Answer:

For the federal government to determine your child’s financial aid eligibility, you must first complete its aid application known as the Free Application for Federal Student Aid, or FAFSA. The FAFSA requires specific income and asset information from both you and your child. Independent students do not need to list their parents’ information.

A specific formula is then applied that results in a figure known as the expected family contribution, or EFC. This figure is the amount of money your family must contribute to college costs for the year before the federal government awards any financial aid. The difference between the cost of attendance at your child’s college and your EFC is your child’s financial need.

The federal government notifies you of the amount of your EFC in a document known as the Student Aid Report, or SAR. The SAR is also sent to the colleges that your child has applied to. When your child is accepted at a college, the financial aid administrator at that school attempts to create a financial aid package that will meet your child’s financial need. The package will include various combinations of loans, grants, scholarships, and work-study programs. If appropriate, you will be given further information on where to apply for various loan programs.

If you’re lucky, your child’s financial aid package will meet all of his or her financial need. However, colleges aren’t obligated to do so. If a college doesn’t meet 100 percent of your child’s financial need, you are responsible for meeting this shortfall. In some cases, you may be able to present special personal or financial circumstances to the financial aid administrator in an attempt to increase your child’s aid award.

How do I know if I’m eligible for federal financial aid?

Answer:

The answer is you don’t, until you apply. For most parents, even two income parents, it’s difficult to predict who will qualify for financial aid. Some families with incomes of $100,000 or more may qualify for financial aid, while those with lesser incomes may not.

Your current income is the main factor that determines whether your child will qualify for aid, but it’s not the only factor. Other important considerations include your assets, the number of children you have in college at the same time, and how many years you have until retirement.

Regarding assets, a common misconception is that all your hard work saving for retirement will count against you come financial aid time. However, the federal government’s formula for determining aid eligibility specifically excludes retirement assets from consideration. The federal formula also excludes home equity (in your primary residence only), cash value life insurance, and annuities. Be aware, however, that a college’s own institutional aid application may include one or more of these assets.

The rule is “When in doubt, apply.” The federal government’s aid application, known as the FAFSA, is free, so all that you will lose if you discover your child is ineligible for aid is just a few hours of your time.  The FAFSA application becomes available on January 1 every year.

Are there any assets that are not counted for financial aid purposes?

Answer:

Yes, assuming you are talking about federal financial aid. Under the federal government’s financial aid formula, four main types of assets are excluded from consideration when determining your child’s financial need:

  1. All retirement accounts (e.g., IRAs, 401(k)s, 403(b)s)
  2. Home equity in a primary residence
  3. Annuities
  4. Cash value life insurance

These assets are known as non-assessable assets. All other assets that belong to you and your child are known as assessable assets and include items like checking and savings accounts, stocks, bonds, mutual funds, 529 plans, Coverdell education savings accounts, custodial accounts, trusts, and investment property. The more assessable assets you have, the more money you will be expected to contribute to college costs before any financial aid is forthcoming.

For example, Mr. and Mrs. Green have a Roth IRA worth $50,000, home equity of $75,000, cash value life insurance of $100,000, and a mutual fund worth $25,000. Under the federal financial aid formula, the Greens are considered to have only $25,000 worth of assets (i.e., the mutual fund).

By contrast, Mr. and Mrs. White have stock holdings worth $50,000, a 529 plan worth $35,000, a Coverdell account worth $15,000, and home equity of $100,000. Under the federal financial aid formula, the Whites are deemed to have $100,000 worth of assets (i.e., stock holdings, 529 plan, and Coverdell account).

Keep in mind that financial aid programs that are funded by individual colleges may use a formula that differs from the one used by the federal government to determine financial need. Specifically, the formula may take into account.

Can an UGMA/UTMA account reduce my child’s financial aid for college?

Answer:

It can, but in the same way that any other asset held by your child can. An UGMA/UTMA account is a custodial account established at a financial institution for a minor child and managed by a parent or other designated custodian. It is established under either a state’s Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA).

Because an UGMA/UTMA account is held in your child’s name, it is considered your child’s asset. The federal government’s financial aid formula treats your child’s assets differently than your assets. Under the current federal formula, children must contribute 20 percent of their assets to college costs each year before becoming eligible for financial aid, while parents must contribute only 5.6 percent of their assets.

For example, $10,000 in your child’s UGMA/UTMA account would result in a $2,000 required contribution from your child. The same $10,000 in your bank account would result in a $560 required contribution from you.

As a result of this formula, any asset that your child holds, including an UGMA/UTMA account, will always translate into a higher monetary contribution to college costs than if the same asset were in your hands. It follows that the more money your family is required to pay up front for college costs, the less financial aid your child will be eligible for. But even though your child will be entitled to less financial aid that may not be such a bad thing. Remember, the main component of the average financial aid package consists of loans that must be paid back.

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