Understanding Fafsa's Treatment Of Investments And Bank Accounts

The Free Application for Federal Student Aid (FAFSA) requires detailed information on tax and assets, including savings and checking account balances. However, it's important to note that not all assets are treated equally in the FAFSA assessment. While a student's assets will have a greater impact on a family's eligibility for financial aid, the FAFSA also considers parent assets, including investments and savings accounts separately. This distinction is made to accurately determine the expected family contribution towards college expenses.

Student assets are weighed more heavily than parent assets

When it comes to the FAFSA, a student's assets will have a greater impact on a family's eligibility for financial aid than their parents' assets. Colleges will generally expect families to use a higher percentage of the assets owned by a dependent student to pay for college. For the 2023-2024 FAFSA, the student asset conversion rate is 20% of the total value when calculating the expected family contribution, while the parent asset conversion rate is 12%. This means that any money in the student's name will be weighed heavily, and it is recommended that cash assets are kept in the parents' names to minimize the percentage weight.

The reason for this discrepancy in weightings is that parents are expected to contribute a smaller proportion of their wealth to pay for their child's college education. The FAFSA formula protects a portion of parents' non-retirement assets, so these may have an even lesser impact on financial aid eligibility. According to the Student Aid Index (SAI), parents should use up to 5.64% of their unprotected assets to help their child pay for college.

It's important to note that not all funds are treated equally by the FAFSA. For example, real estate investments, UGMA/UTMA accounts, mutual fund assets, and 529 plans can reduce the amount of aid one is eligible for, while protected parent assets like 401(k) and Roth IRA accounts will not have any impact.

Additionally, students with parents earning low incomes may have a reduced incentive to work for themselves if financial aid eligibility is at risk. Any money in the student's name will be weighed heavily, and earnings from work are included as part of income, regardless of how they are earned.

To maximize financial aid eligibility, it's crucial to understand which assets are counted by the FAFSA and which are not. Consulting a financial advisor before making any decisions about transferring or allocating assets is always a good idea.

Retirement plans are not reported as assets

The FAFSA (Free Application for Federal Student Aid) requires applicants to report the net worth of their assets when applying for federal student aid. However, retirement plans are notably excluded from the list of assets that must be reported. This includes traditional retirement plans such as 401(k) plans, pension funds, non-education IRAs, Keogh plans, and other similar plans.

Retirement savings are not considered assets on the FAFSA because they are generally intended to provide financial benefits later in life, rather than being readily available money or assets that can be easily liquidated to pay for college expenses. The FAFSA makes a distinction between assets that are readily available, such as money in savings or checking accounts, and future financial benefits like retirement plans or property.

It's important to note that while the value of retirement plans is not reported as an asset on the FAFSA, any untaxed contributions to and withdrawals from these accounts must be reported as income. This includes voluntary contributions to qualified retirement plans, such as pre-tax contributions to a 401(k), which must be reported as untaxed income on the FAFSA. This prevents families from reducing their reported income by increasing contributions to their retirement plans.

Additionally, if your college or university requires an additional application, such as the CSS Profile, retirement savings may be reported on that form and could potentially affect your financial aid offer. The CSS Profile provides schools with more detailed financial information, and they can choose to include or exclude retirement savings when calculating financial aid eligibility.

The intended use of money does not matter

The Free Application for Federal Student Aid (FAFSA) requires applicants to report the net worth of their assets, including money in savings and checking accounts, as well as any future financial benefits, such as property or stocks. The intended use of the money does not matter. This means that any money that is not in a qualified retirement plan must be reported as an asset on the FAFSA, regardless of whether it is intended for retirement or another purpose. For example, if a family sells their home, the net proceeds of the sale must be reported as an asset, even if the family intends to use the money to purchase a new home.

The FAFSA takes into account both student and parent assets, but these are weighted differently. A student's assets will generally have a greater impact on a family's eligibility for financial aid than their parents' assets. Assets in the child's name are weighed most heavily, with colleges expecting families to contribute up to 20% of the assets owned by a dependent student to pay for college. On the other hand, colleges will expect parents to contribute up to 5.64% of their assets.

It is important to note that not all assets are treated equally by the FAFSA. While savings and checking account balances are considered assets, retirement funds and pensions are generally not. Additionally, the FAFSA differentiates between qualified retirement plans, which are not reported as assets, and voluntary contributions to retirement plans, which must be reported as untaxed income.

The treatment of assets by the FAFSA can be a complex and intimidating process, and it is always recommended to consult a financial advisor before making any decisions that could impact financial aid eligibility.

Student income is weighted more heavily than parent income

The FAFSA requires applicants to report income from two years prior to the school year for which financial aid is being requested. For instance, if you plan to start college in the fall of 2023, you will provide income information from your 2021 tax return or W-2 tax form.

The FAFSA formula assesses student income and assets more heavily than parent income and assets. This is because colleges will generally expect families to use a larger percentage of the assets owned by a dependent student to pay for college. For the 2023-2024 FAFSA, the student asset conversion rate is 20% of the total value when calculating the expected family contribution, while the parent asset conversion rate is 12%.

Student earnings can also reduce financial aid eligibility. The FAFSA allows the student to have an income protection allowance, and for the 2023-2024 FAFSA, it was $7,600. Any student earnings above that amount may reduce financial aid eligibility.

The FAFSA formula doesn't expect students or families to use all of their adjusted available income to pay for college. The formula allocates 50% of a dependent student's adjusted available income to cover college expenses and anywhere from 22 to 47% of parents' available income. The higher the parents' income, the more of it will count toward the expected family contribution.

Assets in the child's name are weighed most heavily

When it comes to the FAFSA, assets in the child's name are weighed most heavily. This means that any assets owned by a dependent student are expected to be used to fund their college education, with a conversion rate of 20% of the total value of the asset. On the other hand, parents' assets are only expected to contribute 12% towards college costs.

Because of this discrepancy, it is advisable not to put any cash assets in the student's name before filing the FAFSA. Students are penalised by the FAFSA for saving cash, as the application specifically asks for the current balance of their checking and savings accounts. While the question leaves room for interpretation, as it asks for the balance "as of today", it is best to keep the balance declared as low as possible.

Large cash assets should be kept in the parents' name to minimise the percentage weight. If a relative wants to give money to a student, it is better for them to hold onto the money and provide support indirectly, or to fund a 529 plan, which is assessed at a lower value than cash in checking or savings accounts.

Students with low-income parents may be discouraged from working by this system, as any money earned by the student will be weighed heavily. While the FAFSA does allow for an income protection allowance, any earnings above this amount may reduce financial aid eligibility.

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