Understanding the Financial Aid Formula

If investments alone won't cover the cost of college, your thoughts will probably turn to state or federal financial aid to help cover the rest. And even if your child is years away from hitting the books, there are some basics to consider now that should improve your chances of getting the help you need.

First, and perhaps most important, planners and financial aid experts say you should invest in your name – not in custodial accounts on behalf of your children. The reason: The financial aid formula presumes a greater contribution from students' investments than from yours.

Under the formula, students are expected to contribute at least 20 percent1 of their assets, while parental contributions are capped at 5.6 percent. These are universal thresholds used to determine federal aid eligibility at every college and university.

Arriving at that figure is a process that closely resembles filling out an income tax form. Parents and students must declare all sources of income, including wages and salary, investments, retirement accounts, businesses, and more.

You're then able to subtract out various items, such as earnings from work study programs, scholarships, child support, and the general cost of living. The value of your home is also not included in the net worth calculations, said Scott Atkinson, director of financial aid at the State University of New York College at Brockport, located outside Rochester, New York.

You're required to submit financial information only for the prior year, but you must file a new application form every year. "What they're looking at is a snapshot of your financial picture at a moment in time," Atkinson says.

Parents should file the financial aid form, known as the Free Application for Federal Student Aid, as soon as possible after January 1 every year the student is in college, Atkinson says. You can, and are advised to, file the form electronically at www.fafsa.ed.gov. Generally speaking, you don't have to file additional forms to apply for state financial aid.

The amount of aid depends upon the cost of the institution your child attends. That is figured by subtracting the expected parental and student contribution from tuition, room and board, and other fees. Because the expected parental/student contribution is a constant number, the more expensive the university, the more federal aid the student may receive.

In certain instances, it makes sense for parents and students to spend down assets or take other steps to improve financial aid eligibility, an expert on the subject says.

For instance, families should consider using student assets first to purchase key items for college, such as laptop computers. That would help lower the expected student contribution to college costs under the financial aid formula, said Mark Kantrowitz, author and publisher of FinAid.org, an educational web site.

Here's an example of the effect: If a student has $10,000 in assets, he or she would be expected to contribute $3,500 toward college. But if the student spends half on pre-college expenses, the expected contribution would be $1,750.

Kantrowitz said there are some ways to simply transfer student assets back to parents, but it's somewhat complicated and must be carefully documented. Parents can reduce their contributions by spending assets to pay down other forms of consumer debt, such as credit cards, he added. Student loans tend to have more favorable terms than credit cards.

Another option that helps: having more than one child in college at the same time. That cuts the expected parental contribution in half, Kantrowitz said.

Because it's better to invest in parents' names, planners and experts like to point college planners toward Section 529 college savings plans. Those investments allow parents or grandparents to accumulate money in their own names, but distributions are taxed at the lower student rate. Contributions to these plans are often tax deductible, as well. The chances of a student's receiving financial aid are generally quite high. Atkinson said that an estimated 76% of students at SUNY Brockport receive some form of financial grants.

"The important thing is early awareness," he says.

The State University of New York College at Brockport provides students with a list of the "23 Most Urgent Questions" to ask about financial aid. Among them:

  • Are my college-funded scholarships renewable?
  • What percentage of my financial aid package is in loans?
  • What are the terms of my loans?
  • Will my total needs be met (books, transportation, etc.)?
  • What happens if I need some money in an emergency?
  • Do you have a time-payment plan to help me cover the rest of my college bill?
  • Does your college have a financial aid appeals process?
  • Is my financial aid verified up-front?
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