Family Planning

Understanding the FAFSA and College Financial Aid

Understanding the FAFSA and College Financial Aid
Ann Garcia, Independent Progressive Advisors

Filing for college financial aid is a lot like filing for taxes, especially in that if you understand how the process and formulas work, you can use that to your advantage. As the new year kicks off, many families of college-bound high school students start thinking about how to juggle their finances to improve their chances of receiving financial aid. Here is an overview of the aid process and formulas so your family can make the most effective choices.
Step 1: What type of aid are you eligible for?
Before making changes to your financial picture, you need to first determine what type of aid your student is likely to get: need-based or merit. To do that, use the FAFSA4caster
here to estimate your Expected Family Contribution, or EFC. (To get a more accurate result, add back any pre-tax retirement plan contributions to your AGI from your tax return.) If your EFC is greater than the net cost to attend at the schools you’re considering, then you are more likely to be a merit aid candidate than a need-based aid candidate. Unless you have a lot of flexibility in income and assets, trying to move things around to outsmart the aid process is not likely to be a good use of your time. For example, if your EFC is $32,000 and you’re looking at public colleges costing $25,000 annually, you don’t need to juggle. On the other hand, if you’re looking at schools costing $40,000 and up, there might be opportunities to receive some need-based aid.
Step 2: Understand What Goes into the Aid Formula
The FAFSA EFC has four components:
  • Parents’ Income
  • Parents’ Assets
  • Student’s Income
  • Student’s Assets
Each of these is treated slightly differently in the formula, and the parents’ items are treated more favorably than the student’s.
Each component other than student assets gets an “allowance” amount that doesn’t count in the formula. The allowances are pretty small: for parent income, the allowance is approximately the federal poverty level for a family of that size. Married parents get an asset protection allowance of about $18,000. Students get an income protection allowance of about $6,400. Everything above those amounts, and all included student assets, count towards the EFC, albeit in different percentages.
Step 3: Know What Counts and What Doesn’t
More important than the allowances, though, is what is included or excluded from each component in the formulas. When it comes to income, in addition to the income protection allowance, several items are subtracted:
  • Taxes paid (the exact amount of federal taxes, plus an allowance for FICA and state income taxes)
  • An “employment expense allowance” if all parents in the household work
Other items are added back:
  • Untaxed income such as child support or Roth IRA distributions
  • Pre-tax retirement savings contributions
  • Added to student income is any money received from anyone other than the parent filing the FAFSA. This includes distributions from grandparent-owned 529 accounts and contributions from a non-custodial (on the FAFSA) parent.
On the asset side, the FAFSA excludes several big assets:
  • Retirement accounts
  • Home equity
  • Cash value life insurance
529 plans owned by the parents have many advantages, but being excluded from assets in the aid formula is not one of them.
Step 4: Replace Myths with Facts
One of the biggest myths in college planning is that the formulas penalize savings. In fact, the contribution from assets is negligible: 5.64% of assets in excess of the asset protection allowance actually count towards the EFC. So if a family saved $50,000 for college, after subtracting the asset protection allowance—let’s say $23,600 for this family—their EFC would only increase by ($50,000 - $23,600) * 0.0563 = $1,488. In this case, they come out ahead by $48,512.
Income is by far the bigger factor. As with taxes, income is assessed at progressive rates in the FAFSA formula, with the highest parent “bracket”—47%-- kicking in at “available income” of just $32,300 on the current FAFSA. Students get an income protection allowance of about $6400; all student income above that is assessed at 50%. So a student with $10,000 of income would see their EFC increase by ($10,000 - $6,400) * 0.5 = $1,800.
Which leads us to another myth: that college money coming from grandparents or others never counts in the formula. While it’s true that third-party college savings accounts aren’t reported as assets, any money coming out of them counts as student income in the year in which it’s received. Student income also includes funds coming from the non-custodial (on the FAFSA) parent, if the parents are divorced.
Perhaps the biggest myth is this: You won’t qualify for financial aid, so filling out the FAFSA is a waste of time. The FAFSA serves purposes besides need-based federal aid. Chief among them: it’s required for access to federal student loans (including both Direct Student Loans and Parent PLUS loans), and schools may require it for their own aid programs—even some merit awards.
If that’s the biggest myth, then the second biggest myth is this: Having a low EFC means you will get lots of scholarships. Unfortunately, there is no requirement that a school meet your financial need; in fact, few colleges commit to meeting 100% of financial need, and even among those that do, a substantial portion of the aid package tends to be “self-help” aid, i.e. loans and work study. Knowing how the FAFSA formula works can help you to qualify for additional aid, but a low EFC should only be one of several tools you use to prepare financially for college. Your advisor can recommend appropriate savings and cash flow strategies to supplement your likely aid package.
For more, visit
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