Among the more common misconceptions about financial aid is this long-standing belief: financial aid is determined by income.
Unfortunately for many families planning for college expenses, financial aid depends on much more than just parental income. Eligibility is also determined by how much families have saved for education, among other factors. Here’s how it works.
Estimated Family Contribution (EFC)
The federal government uses a formula to determine how much they should loan/give vs. how much the family (including the student) should be expected to pay for school. EFC is an estimate of how much, in total, the family should expect to pay. It’s based on a few factors:
- Student income
- Parent income
- Student savings
- Parent savings
- Age of the student’s oldest parent
- Total number of children in the family
- How many of those children are currently attending college.
You input all of your financial information into the FAFSA, and the federal government produces your EFC, which will determine your student aid eligibility – how much you can borrow, and how much you’ll receive in need-based grants. The higher your EFC, the less financial aid you are likely to receive.
Planning carefully for EFC
As you can see, there’s a lot to consider when socking away money for college! Throwing money into a student savings account – for generations the preferred method for college savings – can actually increase a family’s EFC, because it’s computed as an asset. Here are the best practices for minimizing the damage:
- If you’re saving money in a traditional savings account, make sure the account is in a parent(s) name. The EFC fluctuates less when the assets are held by older people in the family, like parents. If the student’s assets exceed a standard tax deduction, those assets can weigh heavily on the EFC. The idea is that students are expected to contribute more than their parents to the cost of a college education. Offset that expectation by holding assets in parent names!
- Better yet, avoid the savings account altogether in favor of a 529 plan. This is a plan with built-in tax advantages designed to help you save for future college costs, and parents often opt to open a 529 when children are very young. They come in two varieties: pre-paid tuition plans and college savings plans. Both are excellent options and should be given priority over savings accounts (or birthday money in a shoebox under the bed!) A 529 plan will be made in the parent's name with the student listed as the beneficiary. Having money saved in an 529 will impact your EFC since it is considered an asset and the FAFSA doesn't break out education accounts separately from other assets, but it will be considered a parent asset.
- Another excellent option is the Coverdell Education Savings Account (ESA), formerly known as an Education IRA. This account, like a 529, allows tax deferred growth and tax free withdrawals for education expenses. It does have one unique difference, which is that it can also be used for primary and secondary school expenses before your child even gets to college. Coverdell ESAs are a good option for families who won’t contribute more than $2,000 per year. Because of that lower limit on contributions, we suggest a 529 for families who intend to save more aggressively.
We know, it’s a lot of information! The financial aid process is hardly intuitive, but there are tools out there to help. Start with the FAFSA4Caster to help you estimate how much you will be estimated to receive! This tool, provided free by the department of education, will help you to estimate your federal aid eligibility. Make sure to use the “Help and Hints” on the right if you run into a term that makes your head spin!
The only way to confirm your EFC is to submit the FAFSA and CSS profile (if required by your school) as you prepare for college, but you can, and should, start planning well before that! Minimize the damage to your EFC with the tips above and you’ll be well on your way to maximizing your financial aid.
Need help completing your financial aid forms? The College Planning Center of RI offers free in person assistance. Book your appointment today.