Graduating from college debt-free can accelerate the path to FI dramatically. Brian Eufinger and Seonwoo Lee share their best tips on hacking the FAFSA on today's episode.
Hacking The FAFSA
The FAFSA, Free Application for Federal Student Aid, helps colleges determine how much student aid your student will receive. Understanding how the FAFSA works could save your child thousands with preparation.
It's about knowing the rules. Right, there are very specific rules in life, in all aspects. And the more information you have and the more time you have to plan, the better result you're going to have. And college and college aid is a very high dollar figure issue that many of us are going to be dealing with, either for ourselves or our kids.
Let's start with understanding the terms and the rules surrounding the FAFSA.
The expected family contribution (EFC) is what colleges expect the parents to pay. After filling out the FAFSA, the EFC will be automatically calculated.
Of course, many parents take issue with this because they are unable or unwilling to contribute to the determined EFC. You can use tools like the FAFSA forecaster to determine your EFC in the years leading up to your child's first year of college. The EFC is based on both the parent's and the child's assets. As college gets more expensive, parents are finding that the EFC for each year is becoming too high.
The cost of attendance (COA) offers a more comprehensive picture of the cost of college. It includes tuition as well as technology fees, room and board, books, parking fees, student fees, and more.
If you are unable to meet the EFC at a school, there are many ways to make up the difference. A few include unsubsidized loans, subsidized loans, parent PLUS loans, private loans, kid's savings, generous grandparents, and more. For example, if you receive an EFC of $10,000 but the university costs $50,000, the difference could be made up of loans and other things.
Full Need Vs. Gapping
Through assistance, some schools promise to meet the full need of the student but others practice gapping. Schools that promise to meet full need generally have larger endowments on a per-student basis. With a heavier endowment, they are more able to meet full need assistance promises.
Full need assistance can come in many ways including grants, loans, work-study jobs, and private loans. In a perfect world, all students would be able to have their aid met based on the gap in their needs. However, some schools are unable to do this. This practice is called ‘gapping.' The school basically says that they are unable to help you meet the difference in aid vs. need.
What Determines Your EFC
When filling out the FAFSA, it is divided into sections; parents and students. Student income is weighted the highest. The government expects that students contribute 50% of their income and 20% of their assets to their college expenses. Since you have to fill out the FAFSA four times, your EFC may change slightly every year, they are a good place to start.
As an example, let's say the student has $10,000 in various accounts. 20% would be assessed the first year and go into the EFC. In the second year, there would only be $8,000 to add into the EFC.
Parental assets and income are assessed on a progressive scale, in a similar way to taxes. The assessment for parent's income cap out at 40% and 5.64% for assets.
If you expect that you will be eligible for aid, then having money in your kid's name is not optimal. Of course, if you don’t expect to get any aid at all then you just shouldn’t worry about it.
As far as parental assets, the assets are assessed two calendar years back. So, the parent of a rising senior cannot simply move assets around this year. They would need to do that at least two years in advance if they planned to avoid college costs by moving assets around. So, if your child was going to college in fall 2019, the FAFSA would ask for 2017 tax returns.
Who Should Fill Out The FAFSA?
College is a big purchase, a little bit of financial aid could go a long way. With that in mind, everyone should fill out the FAFSA. Even if you don't expect to receive any aid, it never hurts to apply.
There are three kinds of applicants. The first has a high income with little chance of receiving aid. The second is someone that could optimize their finances and potentially qualify for some aid. The third is someone that is an obvious choice for financial aid but may still need to optimize.
Although stylish pessimism is prevalence among high-income families, it is important to apply anyways. In one example, a high earning surgeon in Atlanta had four kids attending expensive colleges at the same time. She filled out the FAFSA and got a little bit of help on tuition.
The more important reason to fill out the FAFSA is that some schools require you to fill it out in order to compete for their ‘merit aid.' Unfortunately, it seems likely that the financial position of the student is factored into their merit decisions.
What Is The CSS Profile?
The College Board's CSS profile is similar to the FAFSA but some schools opt to use this financial aid form instead. It is a longer form that asks for more details of the family's financial situation. Broadly speaking, the CSS Profile is used by private schools while the FAFSA is used by public schools. The information uncovered by the CSS Profile will be used by each school differently.
The CSS Profile handles financial information differently than the FAFSA. One difference is the parental income of blended families. If there are step-parents involved, then their income may not be counted. Make sure to look into the rules for residency requirements of in-state tuition if parents live in different states.
You can optimize for the CSS Profile instead of the FAFSA if your student prefers schools that use this form.
Overall, Seonwoo does not see a situation where the CSS profile works to your benefit. Plus, there is a fee for the CSS Profile while the FAFSA is free.
Tips To Optimize
If you have limited means, you will look good on either form. If you have more means, then it can be more difficult to receive aid through either form. However, there are ways to optimize your assets ahead of time.
If you are a W2 earner with significant assets, then consider making extra mortgage payments. The FAFSA does not ask about your home equity in a personal residence. One helpful dad had an extensive emergency fund of $110,000 through Ally bank. He decided to pour that money into the mortgage and open a HELOC for the same amount. He essentially eliminated $110,000 in assets that will be considered by the FAFSA.
Listen: Letting Go Of The Emergency Fund
In general, income is income. Whatever assets you report on your taxes will need to be reported on the FAFSA. However, it will add any retirement contribution deductions back in to determine your gross income. Also, interest and dividends earned are treated the exact same way.
Another important tip is to make sure you are getting current and up to date information. If you discover an article from a few years ago, it's very likely the rules have changed and it is old news.
Pitfalls To Consider
A lot of families create college lists with safety schools, target schools, and reached. Mostly, they look like a bell curve of admission difficulty.
Brian recommended a 2 axis approach. In addition to admission difficulty, the affordability of the college should be considered. Too many families just apply to a bunch of schools and hope for the best in terms of financial aid. It can lead to heartbreaking choices later in the year.
The two-axis approach would create four quadrants.
- Easy admission and affordable.
- Affordable but difficult to get in.
- Expensive and easy to get in.
- Expensive and difficult to get in.
Encourage your students to find schools in each quadrant.
If you are helping your child fund their college expenses, then set aside any parent Plus or other loan options. Instead, consider 529 plans and UTMA options as a solution.
There are two types of 529 plans. The first is an investment vehicle similar to a Roth IRA for expenses. As long as you use the funds for education, there are no taxes on the growth. If you don't use the funds for education, there is a 10% penalty on the gains. The second option is a prepaid 529 plan. In other words, you prepay for a semester of college at a time.
If you are going to set aside money for your kids, in general, the 529 is a pretty good option.
With a 529, there is always a custodian and beneficiary. If you are the custodian, then you are the owner in the eyes of the FAFSA.
You can optimize this if you have trustworthy grandparents in the picture. They can open a 529 plan that you fund. When you fill out the FAFSA, the 529 assets are not reported because grandparent's assets are not included. When you take the money out, it will be reported as untaxed income on the FAFSA. So, if you take it out the junior year of college, then these funds will not affect your aid.
Not all 529 plans are created equally. The quality varies dramatically by state. However, even if it has fees it might be worth using depending on the tax deduction benefit. You may be able to open a 529 account in your state and roll it into another state's 529 plan. Most states do not recapture your contributions deduction.
You don't need to do anything specific to rollover your funds between 529s. It is possible to do this year after year to capture the tax benefits and avoid the fees of your state's plan.
In general, a UTMA is not a good way to maximize aid. A UTMA stands for the Uniform Transfers to Minors Act. Depending on your state, you can transfer assets accumulated into a UTMA to your child at either 18 or 21. As soon as a student gets control, it will qualify as a student asset and get assessed at 20% on the FAFSA.
The biggest benefit to a UTMA is that your child can use this money on things other than education.
Order Of Priority
Maximizing financial aid is not a one size fits all process. Here are some general guidelines to consider:
- Use up any non-retirement assets in your child's name.
- Don't use retirement accounts to fund your child's education.
- Use assets in your taxable account first if you know that all the funds in the 529 will be spent.
- Be aware of who has the assets.
- If your kid gets a scholarship, then you can withdraw the amount of the scholarship from your 529 penalty-free.
- Different schools have different rules about scholarships. Some do not allow kids to stack scholarships while others do. Be mindful of that while applying to schools.
Overall, the early planner is rewarded. Take this into consideration as your kids approach college age.
How To Connect
Brain Eufinger through his Edison Prep tutoring service based in Atlanta.
Seonwoo Lee at blog.seonwoolee.com.
The Hot Seat
Seonwoo tackles the hot seat in this week's episode.
Favorite Blog: Doctor of Credit
Favorite Article: Mr. Money Mustache's Shockingly Simple Math to Early Retirement
Favorite Life Hack: Tracking my time.
Biggest Financial Mistake: Not actually considering the cost of college.
What advice would you give your younger self? Try to socialize more.
Bonus! What purchase have you made over the last 12 months that has brought the most value to your life? Robotic vacuum.
- Demystify College Scholarships–Brian Eufinger–Edison Prep
- How To Apply For Scholarships And Win
- The 4 Worst Tax Hacks (And What To Do Instead)
New to FI? Be sure to check out Episode 100: Welcome To The FI Community!