Expert's Corner: Acing Financial Aid Planning

o The EFC is simply a comparative number to help financial aid officers allocate aid. Just because a student demonstrates need doesn’t mean that the school will meet it fully. A recent U.S. News & World Report survey found that only 1% of American colleges promise to meet all of their students’ need. It probably won’t surprise you that these include Harvard and Princeton, schools that are extremely selective. Families should expect to come up with additional resources to pay college expenses over and above the EFC number.

o Strategies that work for public colleges may not apply to private school aid. And since private schools have different guidelines for awarding grants, strategies that work for one private college may not work at another. For instance, some schools include home equity or the cash value of life insurance and annuities in the calculation, and others do not.

o Current income, not assets, carries considerable weight in the financial aid calculation, and it’s a lot harder to shift income until the child graduates from college. Further, parents are only expected to contribute 5.6% of their non-retirement assets to their child’s education annually. The child is expected to contribute 20% of his assets annually.

Second Opinion Step 2: Offer a sound solution

In your client’s situation, removing the UTMA account from the calculation makes a big impact. Keep in mind, however, that UTMAs and UGMAs (Uniform Gifts for Minors Act accounts) are the child’s assets and must be used for his or her benefit. They cannot be returned to the donor under the guise of increasing the child’s financial aid. Instead, consider drawing down the UTMA account first when paying the college bill so that it won’t factor again in the need-based formula. Financial aid is recalculated every year, so it’s worth reapplying annually, even if aid is not offered in the freshman year. Alternatively, the account might be used for other pre-college expenditures for the child’s benefit, like a computer, music lessons, or sports camp. Remember: for incomes under $50,000, UTMAs are taken off the table completely for FAFSA purposes.

The Solution You Propose

You advise your client that a deferred annuity is rarely a suitable investment for a child because of early surrender charges and the 10% early withdrawal tax penalty. After considering various options, the parents choose to move Grandma’s bequest to a UTMA-registered 529 plan. While still legally Junior’s asset, the UTMA 529 plan is treated as a parental asset for financial aid purposes, with only 5.6% of the account going into the aid calculation annually. If used for qualified educational expenses, distributions from the UTMA 529 plan will be free of federal income tax. The move increases the family’s EFC to $17,846 but gives them more flexibility to dip into the account without penalty for Junior’s college expenses. A loophole? Maybe, but this loophole is just smart planning. (Note that contributions to 529 plans can only be made in cash. Liquidating the UTMA account may create immediate taxation.)

Using the EFC calculator, you find that adding back the family’s home equity has no effect on the FAFSA. After talking with the college financial aid office, your client is surprised to find that the college’s guideline only includes home equity in excess of three times parental income. Your client’s home equity is well within that range. While the family may choose to dip into its home equity in the future to help pay for Junior’s college, you warn the parents that it rarely makes sense to incur interest charges earlier than necessary.

Next, you evaluate the parents’ current need for life insurance and make adjustments as needed.

Second Opinion Step 3: Assign some homework

Finally, you remind Junior’s parents that carefully researching colleges is possibly the best time they can spend in the financial aid planning process, and most of the information is free. Advise them to look for private schools with large endowments and state schools with merit aid for good students. They can also search for colleges where their son fits the target student profile, whether in terms of diversity, talent, or another characteristic.

An excellent resource for free scholarship information is FastWeb (www.fastweb.com). Based on information about the student, FastWeb searches a database of awards and identifies only the scholarships that match the student’s profile. Other helpful resources include www.finaid.org and www.usnews.com/fullneed. Finally, if your clients still seem stressed, have them check out the “Five-Minute FAFSA” video on YouTube, which takes a lighthearted approach to tackling financial aid paperwork.

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Tere D’Amato is the vice president of advanced planning at Commonwealth Financial Network in Waltham, Massachusetts. She can be reached at [email protected].