To understand financial aid, you must understand the term, Expected Family Contribution, or EFC.
EFC is the federal Department of Education’s methodology for determining how much a family can contribute toward college.
Important note: EFC is NOT what you will PAY at a particular college. It is a FACTOR used to determine your financial aid award.
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There are more than 70 factors used to calculate EFC. The most important ones are income, assets, number of children in college, and age.
Income is “penalized” between 22-47%, meaning an extra $10,000 of income will cause your EFC to increase between $2,200-4,700, on a sliding scale. All income, including non-taxable income, is in play. Even retirement contributions (meaning that, if you contributed $10,000 to your 401(K) to lower your taxable income, that amount is considered income in the financial aid formulas. I don’t like this either!)
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The formulas penalize assets less severely, but still significantly. Here’s how:
Child assets “count” 20%
Parent assets count 5.64%.
Let’s look at each category, and some important exempt assets.
Money in your child’s name, such as a UTMA or UGMA account, are assessed a financial aid penalty of 20% (or 25% at some colleges). So if you had $100,000 stashed in your child’s name, but I took $100,000 and blew it in Vegas, I would have $20,000 more financial aid eligibility than you.
What about the 529 (College Savings) account?
Under the federal methodology, used by almost all public universities, the 529 counts as a parent asset, meaning that it is assessed a lower penalty. (This is a relatively recent change.)
However, for private colleges with their own endowments, and their own methodology of calculating EFC, I am convinced that most treat the 529 as a child asset: penalized at 20%.
Although this is not great, it does make sense. If you had an account called a “College Savings” account and your child was 17 years old, what else would you use the funds for?
Now let’s look at parent assets, which is simple to explain. That same 100K held in a parent’s name would boost EFC by only $5,640.
What assets don’t count against you in the formulas?
The value of your primary residence is not an asset for federal financial aid purposes, but is under the institutional methodology used by approximately 200 colleges and universities with the own endowments. (All other real estate counts under both methodologies.)
Retirement accounts: 401(K), 403(B), 457, IRA, SEP, SIMPLE and others are exempt (but again, contributions made to these accounts in the “base” year - commonly the year ending in the middle of the senior year of high school - are added back to the income calculation.
Annuities and cash value life insurance policies, but please read this carefully before you sell all of your stocks and buy an annuity! (Note: I am not a licensed agent - I do not have any financial licenses. This section is general information, not specific advice that only a licensed agent can give.)
Last year, I was conducting a workshop on Long Island, when a Stanley, who had driven out from Manhattan, told me that he had completed paperwork to buy an annuity (to shelter his assets in the financial aid formulas) but hadn’t yet sent it in.
What colleges is your daughter thinking about applying to? I asked.
Stanley listed 10-12 colleges, nine of which used the institutional methodology.
Why is this important? The institutional methodology does not exempt annuities!
I told Stanley, who immediately understood that the person most likely to benefit from buying the annuity was his insurance agent...
...Particularly because Stanley was about to write a check for 1.8 Million!
Bottom line: annuities are exempt assets for many, but far from all, colleges.
Life insurance with cash value is an exempt asset across the board (although some colleges, such as Harvard and Hamilton, ask about these as well).
Another exempt asset: small businesses, defined as a business that employs 100 or fewer employees.
The last comment I need to make about assets is that this piece was an EXTREMELY fast, superficial overview of how EFC is calculated. If you are planning on shifting, or sheltering assets from one “bucket” to another, you should be aware not only of the features of the product you’re contemplating (including its pros and cons), but also whether there are any penalties, tax consequences or other negatives associated with terminating a child savings account.
Here’s where you can learn more about the whole shootin' match!
Andrew Lockwood, J.D.
Lockwood College Consulting
497 South Oyster Bay Road
Plainview, New York 11803
516.882.5464
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Disclaimer (to prove that I went to law school): None of the ideas or strategies in this or any communication should be construed as specific, personal advice. The ideas expressed herein are general in nature, not specific to the reader's situation. Some of the strategies or tactics may not work as well as the examples referenced herein. Others may work better than what was described. Please seek an independent tax or other adviser's opinion.
About Andy - Andy is an attorney-turned-"late stage" college finance and admissions consultant. Because of his own horrible experiences with student debt ($100,000 plus between Wesleyan University and St. John's University Law School, where he was trained to write disclaimers like these!), he dedicated his career to helping other children - and parents, avoid needlessly relying on loans and otherwise overpaying for college. See www.AndyLockwood.com for more information.
