29 Oct Strategy for Maximizing College Financial Aid
by Peter J. McKenna, CFP®, MBA, Modera Wealth Management
The costs of obtaining a college degree can be overwhelming. When confronted with this, some of us may be convinced by others to try and increase our chances of getting financial aid. While there’s nothing wrong with this, I‘ve seen a couple of cases where people have received questionable guidance and were led down a path that was ineffective or potentially harmful.
Before you take any action related to financial aid, you need to know enough to ask the right questions. To get started, here’s an overview and key actions every parent should consider first.
There are two primary types of financial aid: merit-and need-based. Merit aid is provided from the school’s resources and is typically given out by schools in a very deliberate manner to attract certain students to their school. The desired students may have athletic, musical, leadership, GPA/SAT scores or other talents or attributes the school is interested in. Your financial situation plays a minor, if any, part in how merit aid is handed out. If your student is only eligible for merit aid, there is no reason to implement a strategy that has to do with need-based aid.
Unlike merit aid, need-based aid can be provided by the federal government and/or the school’s own resources. Need-based aid is less subjective. It is given out to students that meet federal or institutional definitions of need.
To determine if you qualify for federal need-based aid, families need to complete an application called “Free Application for Federal Student Aid” (FAFSA), where a formula is used to calculate how much you could be eligible for.
Demonstrated Need = Cost of Attendance (COA) – Expected Family Contribution (EFC)
In this formula, the “Cost of Attendance” (COA) is the all-in cost of attending a particular school. The “Expected Family Contribution” (EFC) is a calculation based on assets and income of the student and the parent(s) multiplied by various percentage points.
For most families, the income component of the EFC is the primary determinant of how much the family is expected to contribute, but one’s assets can also play a role1. Parent assets in this formula explicitly exclude retirement accounts, the equity in the primary home, and insurance policies. They do, however, include education savings accounts (e.g., 529s), investments, savings, and investment properties.
EFC = Parent Income x (up to 47%) + Parent Assets x 5.64% +
Student Income x (up to 50%) + Student Assets x 20%
Strategy for Increasing Aid
One financial strategy that’s often suggested to increase the likelihood of receiving aid is to shift your assets in such a way that it lowers your EFC. But before doing so, here are some important steps to take first:
> Do the Math
Do a quick before-and-after calculation to allow you to see what impact shifting assets might actually have on the EFC. This EFC calculator is among the best I’ve seen and it requires only a few inputs to estimate your family’s EFC.
For example, moving $100,000 from savings (included) into an insurance policy (not included) may reduce your EFC by $5,640 per year (5.64% parent asset rate x $100K). That could be beneficial, but only if you are getting need-based aid and the school meets all demonstrated need. In many cases, the reduction in EFC from a strategy like this one doesn’t reduce the EFC below the school’s cost of attendance.
> Consider the long-term impact
As with any strategy, you have to weigh the trade-offs and consider the long-term impact. Going back to the insurance example, compare that benefit to the cost of maintaining the life insurance policy for the rest of your life. Even if you can shift assets around to benefit your eligibility for financial aid, make sure it still makes sense over time
> Make sure the advice is objective
Be sure to ask anyone who is suggesting a strategy like this to document in writing a before-and-after view of your financial aid picture and share any financial incentives they may have for recommending them. In the example
above, an insurance agent may benefit from the sale of the policy and may not have your best interests in mind. You want to make sure that their advice is unbiased and comprehensive.
In my role, I have seen planning opportunities that were missed. A widow with lower income, life insurance proceeds, and two kids to put through college could have benefited by shifting her assets to reduce the EFC. Alternatively, I’ve seen a couple of cases where non countable assets like home equity were transformed into countable assets through a cash out mortgage refinancing and then invested in insurance products to get them off the EFC. In the end, the EFC impact of this is zero, but the family now has an expensive insurance policy to maintain and incremental mortgage expense (non-deductible since the proceeds were not used for a home purchase or improvement). Are they better off from this transaction? I’m not sure, which is why I always try and see it from a comprehensive and holistic point of view when making recommendations.
There are changes coming to the FAFSA/EFC process, but the concepts above will persist. Over the coming years, the EFC will transform to the Student Aid Index (SAI). This doesn’t change the nature of the discussion or the concepts, but some of the changes that are coming may change how people plan for the 2024-25 school year and beyond.
If you have questions about any of the above, I’m happy to help.
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