As the cost of higher education continues to rise, more families are becoming concerned about how to afford a college education for their children. In this blog post, we will explore the various strategies related to financial aid, tax planning, and savings options available for families who will be sending a child off to college.

Financial Aid

Financial aid falls into two categories: need-based and merit-based.

Need-based financial aid

As you might expect, need-based financial aid is awarded to students based on their family’s financial need. The type and amount of aid you receive depends on your family’s level of income and assets, the cost of the school, and the ability of the school to meet your financial need.

Need-based aid can include Federal Pell Grants, subsidized student loans – meaning interest does not accrue until six months after the student leaves school, and the opportunity to participate in a work-study program.

You apply for this type of aid by filling out the Free Application for Federal Student Aid (FAFSA) and the College Scholarship Service Profile (CSS Profile).

Some families assume that they will not qualify for need-based aid, but it’s important to remember that the cost of the school plays a big role in the calculation, so the more expensive the school, the more likely you will qualify for aid.

It’s also important to understand how the Student Aid Index (SAI) is calculated – this is the amount you are expected to contribute to the cost of college.

In general, there are four categories of income and assets that factor into calculating the SAI: 

• Parent assets increase the SAI by up to 5.64% of the value of the assets.
• Student assets increase the SAI by 20%.
• Up to 47% of parents’ income is included in the calculation of the SAI.
• 50% of the student’s income is included, but there is an income protection allowance which is subtracted from the student’s income before the 50% is applied, so many students will not have any income factored into the calculation.

You can use this calculator to estimate your SAI.

Merit-based aid

Merit-based financial aid is typically awarded to students based on academic achievement or other factors, usually without regard to financial need. Encouraging your children to apply to schools where receiving merit aid is more likely can be a great way to reduce the cost of college. 

Strategies for Maximizing Financial Aid

Fill out the FAFSA and CSS Profile

You should fill out the FAFSA regardless of your income. Many colleges and universities require it for any form of financial aid, including merit aid and federal student loans. In addition, unsubsidized federal student loans are typically available to anyone who applies for aid. This could be a good way to access financing with favorable terms and no need for cosigners or credit checks.

It’s also critical to understand which schools require the College Scholarship Service (CSS) Profile. Many private schools use the CSS Profile in addition to the FAFSA to assess your financial need.

If your child is applying to a school that requires the CSS Profile, look into how that school calculates what aid you could be eligible for. Unlike the FAFSA, there is no standard formula used by CSS schools to calculate aid. They use what is called institutional methodology. For example, some schools include equity in your primary residence as an asset, while others do not.

The FAFSA and CSS Profile are made available on October 1st of each year (although the release of the 2023 FAFSA is delayed until December due to changes that are being finalized). And you should consider filling them out as early as possible, as some schools consider aid applicants on a first come, first served basis. 

Know which assets will count against you

Assets that are reportable on the FAFSA increase your SAI, reducing your eligibility for need-based financial aid. However, not all assets are reportable. And unlike income, which is counted based on the prior-prior year’s tax return, assets are reported as of the date the financial aid application is filed.

Assets that are factored into the SAI include bank accounts, investment accounts, equity in a non-primary residence or investment property, 529 savings accounts, small businesses, and custodial accounts.

Assets that are excluded from the SAI calculation are qualified retirement plans, such as 401(k)s and IRAs, qualified annuities, equity in your primary residence, and cash value of permanent life insurance policies.

There are several strategies that can be used to reduce your reportable assets for FAFSA purposes:

• Maximize contributions to qualified retirement plans as opposed to saving into taxable brokerage or savings accounts (but be careful to weigh your need for flexibility against the potential benefit of increasing financial aid, as taxable brokerage accounts provide the most flexibility). 
• Use reportable assets that are not needed to pay for college to pay down debt including auto loans and the mortgage on your primary residence. 
• Shift ownership of any assets owned by your child. If you have savings in a custodial (UGMA/UTMA) account that are earmarked for college, you could transfer those funds to a custodial 529 account, where they would be considered assets of the parents and receive more favorable treatment. 

You can use a net price calculator, where you enter information about your family to see what similar families paid at a specific school, to estimate the impact any of these strategies might have on your specific situation.

Remember that these strategies for limiting assets reported on the FAFSA may not be as effective if your child is applying to a school that uses the CSS Profile.

Reduce your income through tax planning

There are several tax planning strategies that can help reduce the income that is used both in the determination of eligibility for tax credits and the calculation of the SAI.

For higher-income families, education tax credits can be hard to come by. The American Opportunity Tax Credit and Lifetime Learning Credit are fully phased out once your modified adjusted gross income reaches $180,000 if you file a joint tax return.

But, if you have the ability to manage your income, doing so strategically can increase your chances of being eligible for these credits while also making you eligible for a larger amount of need-based financial aid. 

The tax year that will be considered on the first FAFSA that you file begins in January of a child’s sophomore year in high school. Beginning in that year, there are several strategies you could consider to manage your taxable income:

• Accelerate or delay the exercise of stock options.
• Strategically time deductible business expenses.
• Consider selling investments held in a taxable brokerage account before January of your child’s sophomore year if you plan to use these funds for college costs and anticipate recognizing significant capital gains.

Appeal decisions if you have changes in income

If your financial circumstances have changed from what was reported on the FAFSA or CSS Profile, you can consider appealing the school’s decision with the financial aid office.

If you had an unusually high income year because of a large bonus or equity compensation, you may be able to successfully appeal for additional need-based aid.

Alternatively, if you receive very different aid packages from what you believe to be comparable schools, you could bring this to the attention of the school that offered less aid. Some schools may make an adjustment, especially if they consider the school offering the better aid package to be a competitor.

Look for schools where merit aid is a possibility

Merit aid is not offered by all schools, so the first step is to understand which schools actually offer this type of aid, what percentage of students receive it, and what amount they typically give out.

You’ll then be more informed about your child’s chances of receiving merit-based aid. For example, if based on information provided by the school, you expect your child will be in the top 25% of students when it comes to test scores and GPA, there’s a good chance merit aid will be available if the school awards aid to the top 25% or more of incoming students.

Look for other types of merit scholarships

Many local and national organizations offer scholarships to high school seniors heading to college. Have your child talk with their school counselor to start putting together a list of scholarships that they may want to apply for.

College Saving Strategies

529 college savings plans are a great vehicle for tax efficient college savings. There is no income limit for taking advantage of the tax benefits offered, and recent changes have created additional flexibility, allowing you to roll unused 529 funds into a Roth IRA if you meet certain criteria.

Superfunding a 529 Plan

Superfunding a 529 plan is a strategy that can be used to maximize the tax advantages available. This allows you to contribute up to five times the annual gift tax exclusion in a single year without facing any gift tax consequences. 

Any investment growth within a 529 plan can be withdrawn tax-free if used for qualified education expenses. So the more time the funds have to grow, the more potential tax savings become available, which makes superfunding a powerful strategy.

State Tax Deductions

Another potential benefit of 529 plans is state tax deductions on contributions. This varies widely, so check the specific requirements of your state to see if this is something you can benefit from.

Grandparent-owned 529 plans

Recent changes to the FAFSA have opened up a new opportunity to reduce your reportable assets. The FAFSA no longer considers distributions from a grandparent-owned 529 plan as the student’s income for financial aid purposes. 

This means that funds used to pay for college from a grandparent-owned 529 (or a 529 owned by anyone other than the parents, for that matter) are excluded from both the parents’ assets and the student’s income when submitting the FAFSA.

Beware of Custodial Accounts

Saving in a custodial account (commonly referred to as an UTMA or UGMA) is less than ideal for financial aid purposes. These assets are treated as being owned by the child, which means that 20% of the balance is factored into calculating the SAI, as compared to parent-owned assets, which only reduce aid eligibility by up to 5.64% of the account balance. As mentioned above, you could transfer these funds to a custodial 529 account, where they would be considered parent assets. Alternatively, you could consider spending down the funds prior to filing the FAFSA.

When savings aren’t enough

When the net cost after need-based and merit aid is more than you have saved, first consider how much you can fund out of your current cash flow. Then weigh the cost/benefit of putting some of your other savings on hold and redirecting it toward college versus taking out private loans or parent PLUS loans to fund a portion of the costs.

Closing Thoughts

Navigating the financial side of the college landscape requires careful planning. Many opportunities exist for both need-based and merit-based assistance. And by filling out the necessary forms, researching scholarships, and maximizing tax planning and savings strategies, you can make college more affordable. Every family’s financial situation is unique, especially when it comes to planning for college, so if you’re looking to speak with a financial advisor, please reach out to us.

Joe Calvetti is a CPA and the founder of Still River Financial Planning, a comprehensive, fee-only financial planning firm that specializes in working with young families and professionals. Click here to learn more about how we work with clients.

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Disclaimer: The information provided above is for educational purposes only and should not be considered financial, legal, or tax advice. You should consult with a professional for advice specific to your situation.