Episode 222: June 7, 2011
Debt Loans Credit
by Laura Adams
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Paying for college and graduate school is a huge financial challenge, and the cost of higher education is likely to continue rising year after year. So whether you’re a parent who wants to pay for a child’s education or whether you’re thinking about heading back to school yourself, it’s smart to start a college savings plan as soon as possible.
How to Get the Most Student Financial Aid
But before you get started, you should know the best ways to save for college that will also maximize your eligibility for financial aid. In this article I’ll give you eight strategies to follow so you qualify for as much federal student aid as possible and have more flexibility to pay those hefty college bills.
The reason you need to be strategic about how you save for college is that having certain kinds of financial assets will count against you and reduce your eligibility for financial aid. Knowing the rules for how financial aid is awarded will help you structure your finances so more of your assets are not included in the formula for calculating your financial need.
Here are eight legitimate strategies to maximize your eligibility for federal student aid:
Strategy #1: Don’t Save Cash in the Student’s Name
To qualify for financial aid for college you have to complete a lengthy form called the Free Application for Federal Student Aid (FAFSA). The information you submit on the FAFSA is used to calculate how much aid you can receive and it generally assumes that a student would contribute a higher proportion of their own income and savings than their parents. So having financial assets in a student’s name reduces aid eligibility. When grandparents want to give money to a student, encourage them to give it to the parents instead (so it’s calculated at the parent’s need rate instead of the student’s) or ask them to pay it directly to the college, if that’s allowed. Also, consider spending a student’s assets and income, instead of your own, before submitting the FAFSA form.
Strategy #2: Use Education Savings Accounts
Coverdell Education Savings Accounts and 529 Savings Plans are tax-advantaged savings vehicles that also get special treatment when it comes to qualifying for federal student aid, so be sure to use them. They’re treated like an asset owned by the parents, even if they’re in the student’s name—which increases aid eligibility as I mentioned in the previous strategy. Additionally, having money in a Coverdell or a 529 plan has minimal impact on the amount of financial aid you can receive.
Strategy #3: Save to Retirement Accounts
Having certain kinds of financial assets will count against you and reduce your eligibility for financial aid.
In general, pensions and retirement accounts, like 401(k)s and IRAs, are not considered financial assets for the purposes of financial aid, whether they’re owned by the student or a parent. Since retirement accounts are sheltered from needs analysis, contributing more to them can increase financial aid eligibility.
However, any pre-tax contributions you make to a retirement account in the tax year before you receive financial aid (that’s called the base year) are included as untaxed income. Additionally, any money you withdraw from a retirement account to pay for school before submitting the FAFSA would count as taxable income and reduce eligibility for the following school year. So you don’t want to make any large contributions to or withdrawals from retirement accounts in any base year.
Strategy #4: Use Cash to Pay Down Debt
Having debt—like credit cards, a car loan, or a mortgage—doesn’t reduce your eligibility for financial aid, but having cash does. So using a reasonable amount of cash savings to pay down debt, or accelerating necessary purchases, is a smart move to make before you submit the FAFSA. However, be sure you don’t drain all your cash reserves because you still want to keep enough cash on hand to maintain a healthy emergency fund.
Strategy #5: Consider the Custodial Parent’s Situation
If you’re divorced, the custodial parent of your college-bound child will be responsible for completing the FAFSA. If he or she is the parent is the one who the student lived with the most during the past year. If he or she is the parent with the least amount of assets and income, that will increase eligibility for financial aid.
Strategy #6: Increase the Number of Household Students
Having multiple children in college at the same time allows you to qualify for more aid. If your kids’ birthdays aren’t less than four years apart, consider whether the oldest child could take a year or two off to work before going to college. Or consider whether it’s a good time for you to go back to school and finish a degree or earn an extra one. When one or both parents return to school at the same time as their children, aid eligibility increases for both the student and the parents.
Strategy #7: Pay with a HELOC Instead of an Equity Loan
If you don’t qualify for enough financial aid to cover all your college expenses and you have home equity, consider using a home equity line of credit (HELOC). A HELOC is a good financing option for school because the interest you pay can be tax deductible and you only tap the amount you need. That’s better than taking out a home equity loan because if you don’t spend all the money you borrow, it’s considered an asset that will reduce your aid eligibility for the following academic year.
Strategy #8: Meet with Financial Aid Administrators
Schools have their own financial aid funds and set their own rules for doling it out. So don’t overlook any strategies that could help you maximize aid that’s available from your institution. Also remember that aid eligibility is always based on the prior tax year—so, if your household or income situation changes, you should make an appointment to meet with the financial aid administrator at your school. They can review your case and may be able to increase your aid package through a process known as Professional Judgment.
These eight strategies aren’t the only ways to maximize your eligibility for financial aid. For more information be sure to check out finaid.org and savingforcollege.com, which are two excellent resources for student financial aid information, advice, and tools.
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FAFSA – Free Application for Federal Student Aid
The Guide to Federal Student Aid 2011–2012
FAFSA4caster – Understand Your Options
The EFC Formula, 2010–2011
Expected Family Contribution (EFC) calculator
U.S. Department of Education
Compare 529 Plans
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