Investing And Financial Aid: Friends Or Foes?

Investing can have a significant impact on financial aid eligibility, and it's important to understand how different types of assets are treated when applying for aid. While certain assets like retirement accounts and life insurance policies are generally not counted, other investments such as stocks, mutual funds, and real estate can affect the amount of financial aid one receives. The treatment of assets also differs between the FAFSA and CSS Profile, with the former excluding certain assets like small businesses and home equity, while the latter includes them. The impact of investments on financial aid also depends on whether they are student or parent-owned, with student assets typically contributing up to 20% towards college costs and parent assets contributing a smaller proportion. Ultimately, the effect of investing on financial aid depends on a variety of factors, including the type of asset, the aid form used, and the specific circumstances of the student and their family.

Student-owned stocks can affect financial aid eligibility

Student assets are expected to contribute a higher proportion of their assets, up to 20%, to pay for their own college education. Therefore, student-owned stocks can have a greater impact on financial aid eligibility than parent-owned stocks.

For example, if a student has $25,000 in a savings account, they will be expected to contribute 20% of the asset ($5,000) each year toward the cost of college under the federal methodology, 25% under the IM ($6,250) and only 5% under the CM ($1,250).

However, there are ways to mitigate the impact of student-owned stocks on financial aid eligibility. One option is to sell the stocks and contribute the proceeds to a custodial 529 college savings plan. A custodial 529 plan is like a regular 529 plan, but the student is both the account owner and beneficiary. The FAFSA treats a custodial 529 plan as a parent asset, which receives more favourable treatment. Parent assets are assessed less harshly than student assets on the FAFSA. An asset protection allowance based on the age of the older parent shelters $40,000 to $50,000 or more of parent assets. Any remaining parent assets are assessed on a bracketed scale that ranges from 2.64% to 5.64%.

Another option is to sell the student's stocks and spend the money on their education. Generally, it is best to spend the student's assets down to zero before touching the parent's assets, as student assets are assessed more harshly than parent assets. For example, if $11,000 in student assets are spent on college costs before the next FAFSA is filed, this will decrease the Expected Family Contribution (EFC) by about $2,200.

However, there are a few caveats to consider. Firstly, if the stocks have appreciated significantly, selling them will incur capital gains, which will be treated as student income on the subsequent year's FAFSA. Student income above an income protection allowance is assessed at a 50% rate. Secondly, increasing eligibility for need-based aid may cause the college's merit-based scholarships to be reduced. Some colleges will reduce their grants when a student receives more aid from another source. Finally, tax credits should be considered. The Hope Scholarship tax credit provides a tax credit of up to $2,500 per student each year based on up to $4,000 in qualified higher education expenses. However, IRS rules do not allow the same expenses to qualify for both a tax credit and a tax-free distribution from a 529 plan. Therefore, it is best to plan on paying for $4,000 in college expenses with cash or loans to maximize eligibility for the Hope Scholarship tax credit.

FAFSA treats custodial 529 plans as parent assets

The FAFSA treats custodial 529 plans as parent assets, which can have a significant impact on financial aid eligibility. Here's what you need to know about how FAFSA treats custodial 529 plans and some strategies to consider:

FAFSA Reporting of Custodial 529 Plans

The reporting of 529 plans on the FAFSA depends on who owns the account. If a dependent student owns a custodial 529 plan, it is reported as a parent asset on the FAFSA, regardless of whether the custodial or non-custodial parent is listed as the custodian. This is because the student is considered the owner, and the custodian is simply acting on their behalf until the student reaches the age of majority. On the other hand, if an independent student owns a custodial 529 plan, it is reported as a student investment asset on the FAFSA.

Impact on Financial Aid Eligibility

The treatment of custodial 529 plans as parent assets can have a favourable impact on financial aid eligibility. Parent assets are assessed less harshly than student assets on the FAFSA. An asset protection allowance based on the age of the older parent can shelter $40,000 to $50,000 or more of parent assets. Any remaining parent assets are assessed on a bracketed scale ranging from 2.64% to 5.64%. In contrast, student assets are not protected by an asset protection allowance and are assessed at a flat 20% rate.

Strategies to Consider

• Change the Account Owner: If possible, change the account owner from the student to the parent. This can help avoid the 50% reduction in aid eligibility based on distributions and instead result in a lower reduction of up to 5.64% based on assets.
• Rollover Funds to a Parent-Owned 529 Plan: After filing the FAFSA, rollover a year's worth of funds from the custodial 529 plan to a parent-owned 529 plan. This way, the distribution is not reported as untaxed income to the student on the subsequent year's FAFSA.
• Wait to Take a Distribution: Consider waiting until the student's senior year in college to take a distribution from the custodial 529 plan. By then, there will be no subsequent year's FAFSA that could be affected.
• Utilise a Sibling's 529 Plan: Take advantage of a loophole by allocating college savings in the custodial 529 plan of a younger sibling. This can help reduce reportable assets for the older child, potentially increasing financial aid eligibility.

Student assets are assessed at a flat 20% rate

Student assets are assessed at a flat rate of 20% when determining eligibility for financial aid. This is in contrast to parent assets, which are assessed on a bracketed scale ranging from 2.64% to 5.64%.

Student assets are expected to contribute a higher proportion of their assets to pay for their education. This means that student assets typically have a greater impact on financial aid eligibility than parent assets.

For example, shifting $11,000 in assets from a student's name to a custodial 529 plan account can reduce the Expected Family Contribution (EFC) by at least $1,600. This could be enough to qualify the student for a small Pell Grant.

Additionally, it is generally recommended to spend down a student's assets to zero before touching the parent's assets, as student assets are assessed more harshly. For instance, spending $11,000 in student assets on college costs before filing the FAFSA can decrease the EFC by about $2,200.

However, it is important to consider capital gains when selling appreciated assets, as these will be treated as student income on the subsequent year's FAFSA and assessed at a 50% rate. To avoid this, it is ideal to sell appreciated assets at least two years before enrollment.

Furthermore, increasing eligibility for need-based aid through the reduction of student assets may lead to a reduction in the college's merit-based scholarships. This is because some colleges will reduce their grants when a student receives more aid from another source.

Therefore, it is crucial to carefully consider the various factors and consult with a financial advisor to make an informed decision regarding investing and its potential impact on financial aid.

Retirement accounts are not counted when determining SAI

When it comes to applying for financial aid, it's important to understand how your assets will impact your eligibility. The Free Application for Federal Student Aid (FAFSA) takes into account various factors, including income, assets, and family contributions. One question that often arises is whether retirement accounts are factored into the equation.

Retirement accounts, such as 401(k), Roth IRA, and traditional IRA accounts, are not counted when determining your Student Aid Index (SAI). This means that the value of these accounts will not affect your eligibility for need-based financial aid. Colleges and universities use the information from your FAFSA and federal tax returns to calculate your SAI, which plays a crucial role in determining your financial need. By excluding retirement accounts, FAFSA recognizes that these assets are intended for retirement and should not hinder your ability to receive financial assistance for education.

However, it's important to note that withdrawals from Roth IRA accounts will be considered. While the value of your retirement accounts is not factored into your SAI, any withdrawals made from a Roth IRA will be counted as untaxed income on your FAFSA application. This can impact your financial aid eligibility, as higher reported income may reduce the amount of aid you receive. Therefore, if you are considering tapping into your Roth IRA to fund your education, be mindful that it could have implications for your financial aid package.

In contrast to retirement accounts, student-owned assets and parent-owned assets are treated differently when calculating financial aid eligibility. Student assets, such as stocks, savings, and brokerage accounts, are generally expected to contribute a higher proportion of up to 20% toward their college education. On the other hand, parent assets have a more limited impact, as parents are expected to contribute a smaller proportion of up to 5.64%. Additionally, certain parent-owned assets, like real estate investments, 529 plans, and UGMA/UTMA accounts, can reduce the amount of financial aid offered, while retirement accounts do not factor into this calculation.

Understanding which assets are counted and which are exempt is crucial when navigating the financial aid process. By strategically managing your assets and staying informed about the latest FAFSA guidelines, you can maximize your eligibility for need-based financial aid and make your college dreams more affordable.

Home equity is included on the CSS Profile form

The CSS Profile uses the Institutional Methodology to determine need-based aid eligibility. In the 2023-2024 application season, the CSS Profile assessed parent assets at a rate of approximately 5%. Home equity is considered a parental asset. So, for example, if a family has $100,000 in home equity, that will raise the parent contribution by $5,000.

Not all CSS Profile universities handle home equity in the same way. Some ignore it, some cap the home equity value at double the family's income, and others don't cap the amount. If a college calculates home equity, 5% is added to the Expected Family Contribution or EFC. For instance, if a family has a home equity value of $400,000, a college that doesn't cap the amount would add $20,000 to the EFC. However, if the family income is $100,000 and the college caps the home equity value at double the family's income, the amount would be $200,000 x 5% = $10,000 added to the EFC.

Some colleges will automatically "cap" the amount of home equity they use, acknowledging the limits that banks put on borrowing against a home based on income. For example, a college's home equity cap could be 1.2x or 2.0x the total parent income. So, if a family with $100,000 in home equity has an annual income of $40,000, and the college caps at 1.2x, they would only use $48,000 of the equity in their calculations. At the typical 5% assessment rate, this capped equity would raise the parent contribution by $2,400 instead of $5,000.

The CSS Profile allows colleges flexibility in awarding their institutional aid. They may decide to cap home equity at a different rate for some students, depending on how much financial aid they want to offer.

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