Student financial aid in the United States Archives

Expected Family Contribution: Digging For (and Finding!) Financial Aid

January 14, 2013 by Average Joe 19 Comments

As you’re waiting for that perfect college to give you the nod, “Expected Family Contribution,” or EFC, is a key term you need to understand BEFORE filling out the FAFSA form (…and you should be filling out the FAFSA form NOW).

Expected Family Contribution is the amount you’ll be expected to pay out of pocket toward your education. Here’s the simple formula:

Cost of college – your need = Expected Family Contribution

Sometimes it’s easier to understand what’s being asked by seeing the equation drawn out. Not to be completely obvious, but that equation makes three points clear:

– You can lower your bill by attending a less expensive institution
– You could attend a more expensive school and not pay a dime more if your need covers the difference between the cheaper school and more expensive school.
– You can lower your Expected Family Contribution by attending a less expensive school, increasing your need, or a combination of both.

Like I said, pretty obvious, huh?

If it was SO obvious, though, why do so many people overpay for college? Not my readers, though, right? We’re so lucky we hang out together!

EFC is about Income and Assets:

An overall note about assets: Assets are excluded for most people with adjusted gross income below $50,000.

Child Money – The FAFSA treats dependent student money as MORE IMPORTANT than parent money in the EFC equation.

Rational? While parents may have other priorities, the child has one: graduate.

Therefore: 20% of dependent and independent student assets count against them when calculating EFC. Little Jimmy’s got $10 in his savings? That’s $2 less financial aid school will give him.

The EFC calculation includes an “asset protection allowance” for parents and independent students with children before ANY money counts against their EFC calculation. How much is the allowance? While the amount varies depending on age and marital status, the average family receives a $45,000 allowance. After that, only 12% of assets are used toward the family EFC calculation.

So, to summarize:

– Parents and Independent Students with Children receive an asset protection allowance of around $45,000
– 20% of dependent student assets are used for the EFC calculation
– 12% of parent assets are used
– 7% of independent students with children assets

Got it? Awesome.

What’s the rational for these numbers? Parents and students with children have to make ends meet at home first, and then can focus some of their money on college. Students in college should spend a higher percentage of assets on education.

I hope you’re starting to see that WHERE you save is an important factor when deciding how to save for college. Clearly, keeping money in a parent’s hands vs. saving in junior’s name can be a good idea in many circumstances.

Big Point: It’s illegal for parents (or anyone other than the child) to remove money from junior’s name to avoid horrible EFC consequences (or for another other reason). However, junior can purchase items beyond food, clothing and shelter with his own money. You can also choose to save more money (or an equal amount) into the parent’s name for college.

Also notice – 529 plans….they’re in a parent’s name.

…and that money in life insurance policies? It doesn’t count against you at all. As far as EFC calculations go, it doesn’t exist.

Want more on the best places to save for college? Check out: College Savings Simplified, The Best Places to Save for Education

Income

Forget full time work for dependent students. It weighs heavily against EFC!

Yeah, I know, you want junior to have a job in college. Guess what? Every dollar junior earns (after a small allowance) counts more severely against his need than income a parent earns. Once again, there’s good rationale for this: junior should be focused on graduating, so if he works, then he should pay every dollar he makes toward school.

As with assets, there is an income protection formula:

– Dependent students receive an income protection amount of $6,000. After that, between 22 and 47% of the amount junior earns is used for EFC calculations. (It’s a sliding scale with percentages rising as the income level rises.
– Independent students with children and parents receive a much more generous allowance. For parents, the number ranges from $16,000 to $55,000 depending on the number of dependents in school and overall family size.

As you can see, parent income counts against need, but once again, parents only have a smaller percentage of their income that counts against EFC.

Rationale? Parents have many priorities besides a dependent student’s education, while dependent students need to save. The EFC allows for a small part time job to learn skills, but punishes students who work full time. Work on graduation!

Good news for me: during the EFC calculation, because I’ll have two in college at the same time, my total parent contribution is divided by two.

Retirement

How do retirement accounts factor into EFC? Money saved into retirement accounts DOES COUNT against EFC. Rationale? You should expect to sacrifice for a short time to help junior through college. If you’re the one headed to school, graduation quickly is your number one priority.

Strategies

If you’re reading this with young children (or just a glimmer in your eye), realize these calculations can change. However, I’ve been teaching clients about EFC since my children were born, and things are roughly the same as they were then. So:

– Save money into the parent name instead of a child’s name.
– Save aggressively into 401k plans BEFORE college years start because you may have to lower your contributions during college years.
– If you’re fairly certain you’ll be a financial aid candidate, cash value life insurance may be an option (although I generally shy away from these products)
– Forget about junior working full time during college. You’ll just elongate the process for him and you.
– Use Junior’s money to buy assets he’ll use during college and for expenses that don’t include food, clothing and shelter. If you’d like, use the money YOU save by NOT covering these non-essentials into a plan in the parent’s name.

Fun, huh? Financial aid programs actually make a ton of sense to me AND it becomes much clearer HOW to save when you know the keys to the FAFSA and EFC.

What parts of financial aid are most confusing to you? Leave them in the comment section and we’ll try and tackle those next.

This is only one piece of an overall college financial plan. Check out: 5 Steps to a Successful College Financial Plan.

Photos: College student w laptop: Ed Yourdon;

College Savings Simplified: The Best Places to Save Money For Education

February 14, 2012 by Average Joe 3 Comments

While I tend to do things the hard way, finding college savings isn’t one of the areas where I complicate a task. For some reason, my sixteen year old twins helps me focus on whether a 529 plan, Roth IRA, or savings bonds will treat me right.

So, even though I’ll generally remember to add softener to the washing machine just after it’s finished, I understand how college plans operate up and down.

If you’re saving for college, it’s important to categorically work through the details of each plan to determine which best fits your needs.

…because there IS A right way to save for college, and a wrong way to save.

The bad news? The BEST way to plan college savings differs depending on who you are and what your circumstances may be.

I know that sounds generic and evasive, but it’s true: the best way to save for college will depend on your own income, current savings and college goal, so the best course of action will be this:

Know what plans exist and how they’ll affect your ability for financial aid before investing a dime.

If you haven’t yet, you should read the pieces on:

– 5 Steps to a Successful College Plan – This will guide your plan of attack when creating a college plan.

– Narrow Your College Search – This will focus your college search to those schools which are the best fit, both financially and for your particular interests.

After reading these two thorough primers, you’ll be armed with an idea of the cost and feasibility of your favorite school.

Let’s now save for the goal: education.

Complicated Ways to Save For College

Some methods of saving for college are so fraught with risk that I’m reticent to ever recommend them to people. That doesn’t mean that these college savings plans are bad; on the contrary, they all have some huge upside potential, provided that all the right conditions exist. Here are a few:

In-State Tuition Reimbursement Plans – Many states offer plans which reimburse the cost of college credits at a later date. This can be a fantastic way to lock in the price of a college, provided that everything goes according to plan.

Upside: Paying today’s rates for in-state public institutions. Don’t have to worry about market conditions or returns on investment.

Downside: Have to worry about state plan solvency. More than one state has already notified participants that they might not be able to meet their obligation. In fact, some plans no longer guarantee that your dollars will lock in present rates. Instead, these plans invest your money with state funds. Who wants their state government as a money manager?

Life Insurance – Some life insurance plans, such as whole life and universal life are presented as attractive options for education savings vehicles.

Upside: These plans are financial-aid friendly. When completing a FAFSA application, money inside of life insurance policies doesn’t count against your savings, acting as a nice shelter. Also, if for some reason the insured passes away, money is available for education.

Downside: You may have to cancel your life insurance policy to withdraw education funds. What if you still need the policy? Also, do you really need life insurance? If the answer is yes, and you’re sure that you will no longer need coverage after this incident, then this might be a good option.

Watch out for fees, too. Not only will you pay for insurance, but often a policy which offers stocks and bonds are filled to the brim with fees to manager and (maybe more importantly) to withdraw funds.

Still want life insurance in your account? Read this good article at FinAid.org for a more in-depth argument: Variable Life Insurance Policies.

Annuities – Tax deferred savings may seem like a good option for education planning. Why save into an account that’ll be taxed every year when you can shelter your money?

Upside: These accounts are FAFSA friendly, meaning that they are not usually counted in the equation for financial aid. Many annuities offer some flexible savings options.

Downside: Too many to mention here, but mostly: fees and penalties. Make sure you’re going to be over age 59 1/2 before you remove money, because if not, there’ll be IRA penalties on top of whatever the annuity company may charge.

Taxes can be a bear. Here’s why: when you withdraw cash, dollars in the account are removed in a LIFO (last in-first out) accounting manner. This means that all interest on the account must be taken before principal is removed. Why is this a big deal? Taxes. You’ll pay taxes as if you earned the money in the year you remove the money. This income may also make your chances of receiving financial aid worse in the following year.

Less Complicated But FAFSA or Tax Return Unfriendly

Stocks or Stock Based Mutual Funds – These accounts can be used whenever you wish, assuming the dollars aren’t inside of a tax shelter. In some years there’s a chance of nice returns, too.

Upside: Returns. While there are no guarantees, over long periods of time the instability of a stock or stock-based exchange-traded fund or mutual fund can be countered with a high average annual return.

Downside: Risk. There is a chance you could lose a substantial amount of principal if you don’t monitor or manage your money. Also, this type of investing isn’t FAFSA-friendly. Dollars that aren’t sheltered count directly against your chances of financial aid.

Bonds or Bond-Based Mutual Funds – More stable than stocks, these types of funds have performed attractively over the last ten years.

Upside: Returns with generally less risk than stocks above. Because bonds throw off dividends as one of the main methods of creating returns, these investments often perform more consistently than stocks.

Downside: Taxes. Bonds often throw off an attractive dividend that savers often reinvest. This money, unless it comes from a special type of bond such as a municipal bond fund, is taxable every year, slowing down your return. While there has been tax reduction with capital gains taxes, these are taxed as income, which is a much higher tax bite. These are also FAFSA unfriendly investments, unless you use government savings bonds. These can be good to you tax-wise, as long as they’re titled correctly and cashed in the same year as you’re paying qualified education expenses.

The Easy Way To Save For College

Roth IRA Plans – A Roth IRA is generally a retirement savings vehicle. Money invested gives you no tax benefit today, but can be taken tax free during your retirement years. You’ll have to follow a few rules, but you are allowed to withdraw funds for college. You may also use nearly any time of investment you choose inside of a Roth IRA.

Upside: Tax shelter. This money can grow tax deferred for education, and if you end up not using it can be used later for retirement, tax free.

Downside: Retirement savings. The best use of a Roth IRA is clearly as a retirement savings vehicle. While money can be used for college, why miss out on the main Roth opportunities around retirement?

Coverdell Education Savings Accounts (ESAs) – These plans allow you to save not only for college, but also for earlier years of private school expenses.

Upside: Flexibility. This tax shelter allows you to use money for many types of education options, so it’s great if you’ll have elementary, high school and college savings needs.

Downside: Funding. Man, these accounts are small. Because you can only place $2,000 per year into this type of account, they often don’t make sense. I’d also meet people with very limited funds in a few different Coverdell IRAs. Who can manage all these little accounts effectively?

The IRS page on Coverdell ESAs is very helpful. Find more details here.

529 Plans – State sponsored education plans offer a good tax shelter, are somewhat FAFSA friendly, and eliminate taxation of dollars as long as funds are used for qualified education expenses.

Upside: Amounts of savings. You can pack tons of money into these plans. Most allow as much as $300,000 to be invested into a 529 account. These accounts can either be in self-directed fund options or can be in age-based options. If you don’t use the money for the primary beneficiary, funds may be used by siblings, parents, children or other close relatives. In these plans your choice of education institutions isn’t limited to a single state. You may use these dollars in any state and still receive the tax benefit.

Downside: Money earned in a 529 plan must be used for education expenses or you’re slammed with penalties. If you aren’t sure about saving for college, funding your Roth IRA first might be a better idea, because while these funds are flexible for college funds, money will be trapped here.

Of these, the savings option I like best is a 529 plan, because of its flexibility, range of schools that accept funds, and tax treatment. While it isn’t best for everyone, for the vast majority it’s where you should save for college.

Here’s How To Evaluation 529 Plans

Just like we’ve told you previously that Morningstar is the best way to evaluate mutual funds, I like savingforcollege.com to evaluate 529 plan options.

Here’s a link to savingforcollege.com. Have a look around to see how thorough this site is on investing for education.

The Good – Lots of information on FAFSA and college savings options. Great reviews on the fees associated with 529 plan savings accounts.

The Bad – While fees are certainly important, I’m about returns. Savingforcollege.com does a poor job of comparing how money managers work unless you’re willing to fork over some money for a premium membership. When compared to more robust money management sites such as Morningstar.com, there’s no reason to pay for this information.

Can I recommend a single-best 529 plan?

Absolutely not.

Check your state’s plan options at savingforcollege.com to see how they stack up. Always evaluate a few national plans to see how they compare against your own state’s options.

My favorite national plan is UPromise, though I also like the T. Rowe Price option.

Why Upromise?

I’ll attack this next week, but here’s a preview: not only is the plan managed better than most options available, but if you sign up your credit and debit cards, but using the Upromise Rewards program (which you can sign up for whether you use a Upromise 529 plan or not) you’ll receive points which can translate into extra money into the 529 plan later. Combine the benefits of low cost investing, good management and extra money, and you’ve found a plan that’s hard to beat.

If you want to compare Upromise with your state’s plans, here’s a link for more information: Upromise is the smart way to save for college!

5 Steps to a Successful College Plan

January 31, 2012 by Average Joe 7 Comments

My personal bar for my children’s education is modest. I hope they’re happy and successful enough that they won’t need to live at home. That’s it. Sure, I’d love for them to have wealth beyond measure (or at least enough to support ‘ole dad in his golden years), but that’s icing on the cake.

I know for certain they’ll need a solid education to have a leg up when searching for a job. Paying for college isn’t a gift to my kids…it’s a gift to me and my own retirement plan….without children begging me for cash.

If you haven’t thought about how you’ll plan for college, now is a great time.

Here are the five steps you’ll need to navigate to create a successful college attack:

What’s Your Target

If junior is only two years old, it’s impossible to discern whether that giggle means she wants to attend Harvard or the local community college. But because a college degree is so expensive, parents need to decide what they can afford early on to set a reasonable target.

Decide these three points as soon as possible:

– What type of school would you like to afford?

– How much college should your child pay for on their own?

– What are you going to do to help junior find money to afford their portion (assuming you’ll make junior foot some of the bill)

Once you’ve determined the type of school you’d like to afford, now we know what we’re aiming for.

Price Your School

Here’s the single most ugly step in planning for education: peeking at the price tag.

Unfortunately, it’s impossible to create a successful college plan without knowing what it’ll cost. Visit college websites to determine how expensive your little pride-and-joy’s educational journey is going to be. As I just mentioned, this eye-popping experience may cause you to rethink point #1 above. In my experience helping clients plan, we’d set some lofty college goals, knowing that at the very least, if they miss the top rung, they’d still be able to afford the next lower rung.

According to FinAid.org, it’s a good idea to plan on education costs rising at double the inflation rate. This means that a number around eight percent inflation would work as a conservative estimate.

What does this mean? When you begin putting money aside, you aren’t going to need to save today’s costs of an education. Au contraire, you’re going to need to meet the cost in future dollars. That means that you’ll need to use a calculator add eight percent per year to today’s cost to find out the true goal. Armed with this number, you’ll then backtrack to today to find out how much you’ll need to save per month to reach your future education cost goal. Now you have benchmarks and a target. Game on!

Understand Financial Aid Programs

Many people understand that saving into an IRA plan can damage your retirement plan if you’re going to leave work at age 35. These same people fail to realize that certain ways of saving can severely impact the amount of money you’ll need to save for college for your children. Simply put, different than retirement–which you want to enjoy–college is an experience to survive. If you can succeed in finding a prestigious institution that will cost you nothing to attend, that’s fantastic. For most, the goal is “maximum education for minimum price.”

To receive the minimum price, you must pay attention to how you save money. Colleges will only subsidize your education if you qualify in one of three areas:

academic scholarships.
athletic scholarships.
need-based aid.

If your child is young enough, you can help junior secure good grades to possibly qualify for an academic scholarship. Qualifying is half of the battle. The other half is actually finding and applying for these opportunities. While colleges try and lure the best and brightest they can find, your child in one of millions who’ll attend college some day. Much like a car dealership has to advertise a good deal, you’ll need to advertise your student.

That sounds awful. I’d just rather focus on grades.

Great. I promise you that someone who markets their grades will find many, many opportunities that the person who just focuses on grades alone will find. Hunt. Search. Show off your honor roll student. Colleges will pay you back by showing you opportunities you may not have discovered if left on your own.

Although every parent would like to think that their gifted athlete is headed for an NCAA Division I scholarship, this isn’t normally the case. There are far more gifted athletes than there are programs available. Even if you do have a child with a natural ability to run, jump or throw, you’ll need to still shop your athlete to schools to make sure coaches know you’re interested.

Scholarships often go to students who successfully market themselves rather than the most qualified individual.

That leaves need-based aid programs. A dollar saved depends on how it’s saved. If it’s saved in the students name, it counts differently than if it’s saved in a parent’s name. Also, money in a retirement plan is counted differently than cash in the bank. How you save is vitally important when a college is counting up how much you have. Do yourself a favor and learn how schools count before filling out aid forms. Colleges use a formula called “expected family contribution” to determine how much you’ll be able to afford. Learn this formula. In fact, if possible, find out before you begin saving for college so you’ll have funds in the most appropriate spots to qualify for the maximum amount of aid possible.

Decide How You’ll Save

Popular savings vehicles such as stocks, mutual funds, 529 plans, pre-paid plans, Roth IRA investments and savings bonds all have distinct advantages and disadvantages. The type of fund you use will play a huge role in your savings plan.

Begin the investment selection process with your time frame. For short-term savings, 529 plan (low-risk options) and savings bonds offer safety that others cannot. Long term savers may choose more aggressive options, such as stock-based mutual funds, exchange traded funds or real estate investments.

Here’s the big key: sheltering your money is every bit as important as picking the right investment. Because 529 plans, pre-paid options, a custodial account and IRAs will affect a family’s expected family contribution for college, it’s important to understand the affects of these shelters on possible aid packages once junior reaches college age. Also, many plans have penalties for early withdrawals or withdrawals for anything outside of qualified college expenses.

Writer Stephen Covey talks about picking up a stick in his book 7 Habits of Highly Effective People. He says that when you pick up one end of a stick, you also pick up the other end. How does this apply to college savings? It’s simple: it’s every bit as important to know how you’ll withdraw money from a plan when you open it as it is to understand funding methods and available investment options.

Apply for Grants, Scholarships and Aid

Finally, you’ll want to focus on a few opportunities where you know you stand a chance of possibly finding funds to help pay college costs. Generally, people don’t just throw money at college programs. There is often something in it for the organization distributing money. By understanding what they want from the student, it’ll be much easier to secure help than by simply thinking that someone is just going to gift your son or daughter a college education.

Schools may want work-study, banks want interest on loans, companies may want a contract for your student’s work. Create a list of grants, scholarships and aid and learn the process of applying for each of these important programs. Many use a form called the FAFSA (Free Application for Federal Student Aid). Read this form ahead of time to learn what questions will be asked.

Some universities offer financial assistance, depending on the student’s need and his or her academic potential. These students will have to fill out the FAFSA and then set up an appointment with the school’s admissions adviser to discuss potential solutions. Setting up this appointment is also a great idea to find out about scholarships and employer tuition reimbursement programs. If you are already working, speaking with your employer about helping you out with your tuition costs can’t hurt and could benefit both parties in the future if you earn your degree and stay at your current job.

Hopefully, this will help distill your successful college plan process into bite-sized morsels to attack. Clearly, there are nuances in each of these five steps. However, by breaking them down into these pieces, you’ll find that what might have seemed like a Herculean task is really a manageable process that you can navigate if you have a little patience and start right now!