With the high cost of attending college, maximizing financial aid is essential toward building a strong financial future. FAFSA (Free Application for Federal Student Aid) is the largest provider of needs-based financial aid for more than 13 million students through grants, loans and work-study funds.
FAFSA collects information on the finances of the student's family to determine an expected family contribution (EFC). This is the minimum amount a student's family will be expected to pay toward the cost of their education.
The EFC takes into consideration the size of a family and the number of children in college. All students are encouraged to complete a FAFSA application even if they don't expect to qualify for aid.
The primary factors used to determine the EFC are the income and assets of the parents and student. FAFSA considers 20 percent of the student's assets, 50 percent of the student's income, 2.6 percent to 5.6 percent of the parent's assets and 22 percent to 47 percent of the parent's income. The amount of parent's income that is considered is based on a sliding scale.
Recent FAFSA changes allow students to complete the annual FAFSA application as early as Oct. 1; previously, applications were not accepted until Jan. 1. Students are encouraged to apply as early as possible. Recent changes also require income to be reported from one year earlier than previously required. For example, students and parents must report income from 2016 to be considered for aid in the 2018-19 school year.
Therefore, any decisions made to minimize income must be considered two years before the student begins college, and income earned after the student's sophomore year won't affect FAFSA. From the second half of the student's sophomore year in high school through their sophomore year in college, minimize income and avoid transactions that may unnecessarily increase income such as Roth IRA or 401(k) conversions or the sale of assets for a significant gain.
Assets are reported based on the fair market value at the time the FAFSA is completed. Retirement assets such as 401(k) plans and traditional and Roth IRA accounts are not included in the asset calculation, but distributions made from these accounts can be included in income. Additionally, tax-deferred contributions made to retirement accounts are added back to income on the FAFSA but won't be included in the asset calculation. Investments held in taxable accounts including savings, checking, money market, mutual funds, bonds and stocks are included in the asset calculation.
A 529 college savings plan for a dependent student beneficiary is treated as a parental asset if it is owned by the parent or student, and 529 plans owned by grandparents are not included in the asset calculation. However, distributions from the grandparents' 529 plan used for education are treated as income. It's best to use these funds during the student's last two years of college when they won't impact FAFSA. Assets held in UGMA (Uniform Gifts to Minors Act) and UTMA (Uniform Transfers to Minors Act) accounts are treated as student assets, so consider transferring them to a 529 plan to be treated as a parental asset.
Jane Young is a fee-only certified financial planner; questions regarding this column can be sent to firstname.lastname@example.org.