Paying for a college education is one of the biggest outlays any family will ever make, so they should take notice of several new developments that can help finance rising college costs.
For starters, the interest rate on federal student loans for the 2016-2017 academic year has declined a little more than half a percentage point. Loans issued after July 1 carry a 3.76% rate for undergraduates, down from 4.29% last year, and 5.31% for graduate students, down from 5.84%. PLUS loans for parents of undergraduates and graduate students will charge 6.31% interest, down from 6.84%.
Equally or more important is the change in the filing date for the Free Application for Federal Student Aid (FAFSA), which is the primary source that public and private institutions use to calculate a student’s eligibility for financial aid.
Families and students can now file the FAFSA beginning Oct. 1 for the 2017-2018 academic year, using income tax returns from 2015, which will also be used for the current 2016-2017 academic year, doing double duty during this transition period. Even if families don’t think their student will qualify for federal aid, they should file the FAFSA anyway because most colleges require it be filed before considering an application for student aid and because their student may qualify for some assistance.
Previously, families would file the FAFSA starting Jan. 1, estimating their income taxes for the previous year, then updating the information once their taxes were filed. Now the lookback will be two years beginning with the 2017-2018 academic year, and there will be no need to estimate income taxes and then revise them.
“This is good because you don’t have to estimate … and it also speeds things up a little bit,” says Matt Sommer, vice president and director of the retirement strategy group at Janus Capital Group.
“People will find out about their [financial aid] awards sooner [and] people can make their decisions about where they want to go to college sooner.” But he cautions all those families who have grown used to the Jan. 1 FAFSA deadline for the upcoming year: “Before you know it Oct. 1 will be here and you don’t want to be flatfooted.”
These changes in the FAFSA filing calendar also change the strategies that families can use in order to maximize their student’s chances of qualifying for financial aid. Here are some strategies they should consider, according to Sommer.
Delay Recognition of Income
Since the new FAFSA rules take into account income earned two years prior, parents of future college seniors should try to delay recognizing income until the tax year that lands at the beginning of their student’s junior year.
For students who will be sophomores this upcoming academic year — and seniors during the 2018-2019 academic year — that means delaying the recognition of income into 2017 because it won’t be included in the FAFSA filing for that senior year. Parents could delay selling appreciated securities or taking a distribution from a tax-deferred retirement account until 2017.
“Deciding not to take an IRA distribution, for example, in November or December and waiting until January of 2017 could considerably help with their senior year financial aid package,” says Sommer.
Time 529 College Saving Plan Distributions
There are two key points to remember when filing the FAFSA. One, the expected family contribution to finance the cost of college is based on a calculation that gives much less weight to parents’ assets (5.64%) than students’ assets (20%). The lower the EFC, the bigger the potential need for financial aid. Two, qualifying distributions from 529 College Savings Plans, whether owned by a parent or a student, are considered a parental asset, while distributions from a 529 plan owned by a grandparent are considered a student’s income.
Given the two-year lookback, then, families can maximize their chances of a student receiving financial aid by using parental and student-owned 529 plan distributions during a student’s first two years of college and grandparent-owed 529 plans during the last two years of college. Maximize Gifting Opportunities
Grandparents — and others — have additional options that won’t affect aid eligiblity if used to finance the last two years of a student’s college education. They can give unlimited amounts of money directly to a college on behalf of a student without triggering a gift tax while simultaneously reducing their potential estate tax liability.
They can also gift appreciated assets to a student. If the student is 24 or older and in the 10% or 15% lower tax bracket, the gains collected when he or she sells that asset won’t be taxed because there is no capital gains tax for those in the lower tax brackets. Students younger than 24 who are single and attending school full time, however, would be subject to their parent’s income tax rate for those gains, under the “kiddie tax” rule.
Spend Custodial Account Assets Two Years Before Freshman Year
A custodial account in the name of a child, known as the Uniform Gifts to Minors Act (UGMA), account, is considered a student asset for purposes of FAFSA. In order to limit the impact of those assets on potential financial aid because they have a heavier weighting in FAFSA calculations than parental assets, families may want to spend down those assets two years before a student’s freshman year. Under the law, those assets must be spent on products or services that benefit a child, so they can be used to pay for summer camp, laptop computer or academic tutoring, for example.
Another strategy, according to Sommer, is to liquidate the custodial account, which would trigger capital gains tax on any appreciation, and invest the proceeds in a 529 plan whose assets will be considered parental assets for purposes of the FAFSA and whose earnings wiil compound on a tax-deferred basis and distributions will be tax free.
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