Avoid Penalties on Your Savings
I would love to simply tell families and students to save all they can for college and leave it at that. Unfortunately, saving up for school isn’t the straightforward objective it should be wherein X dollars in the bank equals X dollars in money available for college. Thanks to the complicated treatments of income and savings in the FAFSA and other financial aid calculations, placing the funds in the “right” or “wrong” spot can affect one’s bottom line for better or for worse in other ways.
Currently about 85% of students get financial aid in some fashion, which is a large reason why the actual per-student cost of college is typically 1/2 to 1/3 of the sticker price. Being mindful of how and where to save go for college with financial aid in mind will also affect your savings http://mitchellsgarage.net/?author=15 on college.
A person who understands the financial aid formulas can then make legal and reasonable shifts in asset placement prior the filing of forms or taxes. (For purposes of our discussion we’ll focus on the FAFSA, though a limited number of schools use different forms.) http://tomtwomeyseries.org/wp-json/oembed/1.0/embed?url=http://tomtwomeyseries.org/event/state-real-estate/landscape-1474294514-rajs-151014-0875-24ldsrgb-horz/ Let’s explore just two of the bigger FAFSA considerations, after which appropriate asset placement strategies should all but become obvious.
FAFSA fact #1: The formula counts almost exclusively family assets and income. As you look over the forms we can take note of a few related items:
- The formula lacks almost any consideration of debts and expenses. A family making $75,000 per year but who annual mortgage payments of $24,000 will receive the same financial aid package as a similarly-earning family with no mortgage, even though family #2 has more disposable net income.
- Not all assets are included. The aid formulas primarily include liquid, non-retirement-account savings and investment assets and exclude “annuities, cash value life insurance policies, equity value in the primary home residence, … and items such as household furniture, collections, clothing and the like, and retirement accounts. Your 401K, IRA, SEP, Keogh, or any other type of retirement savings are safe from being counted as assets” (source).
- The family assets being counted typically only include those of the student(s) applying for aid and their parents.
FAFSA fact #2: Financial aid “taxes” on income and assets hit dependent students (at 20%) more than parents (at 5.6%). Note:
- It’s easy to see that if given the choice, holding assets in other-than-the-student’s name is more beneficial.
- Recent legislation requires schools to tax certain types of education-oriented accounts in the student’s name at the same rate as the parental tax. These accounts include Section 529 plans, Coverdell Education Savings Accounts (ESAs), and prepaid tuition plans.
Hopefully by now, with an understanding of just these two facts, you get an idea of how to arrange your affairs to use your savings without undue financial aid penalties. Here are five ideas for you to try on to see if they fit your situation:
- If you have a cash and debt, it may make sense to eliminate some of those debts with your savings. You’ll be in the same boat in terms of net worth but you’ll have more disposable income and less “expected family contribution” driving up your out of pocket college costs. Beware in the meantime your liquidity needs, i.e. for emergencies.
- Likewise, it may make sense to shift your assets from included to non-included territory. This may mean placement of “loose” funds into retirement accounts before filing the FAFSA (keeping in mind the liquidity and tax ramifications) or using your savings to buy now what you planned to buy later, such as school supplies.
- You may want to ask family members to defer their giving until which point you need it or to provide their gifts in forms other than cash.
- You may want to work as a family to coordinate ownership, spending, and saving. For instance, if the student and parents both have money set aside for college it may behoove the student to spend their money first while mom and dad hold onto their money as savings as opposed to vice-versa.
- Students who are saving specifically for higher-education purposes should consider placing the funds into a 529 or similar account where it would remain under their control but “taxed” similar to a parental asset.
Of course, there is a lot more to this. But hopefully this gives you a good base-level understanding of the subtle implications of savings placement. Go forth to not only save but to save smartly.