The EFC and how it affects your financial aid

One of the more daunting challenges for parents is understanding how colleges determine what a family may or may not receive in financial aid. Articles often discuss the FAFSA form, but may not go into depth on how income and assets are assessed. In addition, many parents are unaware there are actually two different aid eligibility formulas for EFC (Estimated Family Contribution). These formulas are similar in some ways, but the resulting figures can widely vary depending upon a family’s finances.

The first formula is called the Federal Methodology (FM) and uses the data entered on the FAFSA form to calculate EFC. The FM-EFC is used by most public colleges and some private colleges. The FM takes the parents Adjusted Gross Income (AGI), adds untaxed income such as retirement plan contributions, deducts state/local taxes paid as well as some Income Shelters, and the result is Assessable Parent Income. The formula then looks at Parent Assets, exempting personal items, home equity, retirement accounts, and annuities or life insurance cash values. From the value of the rest, an Asset Protection Allowance is deducted and the resulting figure is multiplied by 12%, ending up with a Discretionary Net Worth figure. This DNW is added to the available income and multiplied by 22-47%, (a higher figure means a higher assessment) to result in the so-called Parent Contribution. Student income is assessed at 50% above $6000 and financial assets of the student are assessed at 20% of value. The combination of all three factors results in the FM-EFC.

The other formula, the Institutional Methodology (IM) is similar, but uses information provided by the CSS Profile application form, required by most private colleges and a few public ones. While Parental Income tends to be the chief factor in the FM-EFC, parental assets may play a larger role in the IM, primarily due to the IM’s inclusion of home equity (FMV – mortgage debt) as a countable asset. The CSS Profile (along with a possible supplemental application by the private college) looks more closely at the family’s finances. Finally, student income receives no income shelter as in the FM and student assets are assessed at 25% instead of 20%.


Do be aware of filing deadlines

The FAFSA may be filed anytime after January 1 of the student’s senior year of high school until July. But don’t wait too long. Financial aid is often a “first-come, first-receive” deal, so try to file the FAFSA no later than January or February. Most private schools will require families to file the CSS Profile by February 1st or 15th, so it makes sense to complete both of these forms together. Check with each schools filing deadlines.

Do make sure all data entries are consistent

Those colleges asking for both the FAFSA and the Profile will look at figures on both forms for inconsistencies. Make sure you are consistent on all data entries for both forms.

Do take steps to minimize reportable income

To maximize eligibility, take steps to minimize reportable income and reportable asset values during the “base income years” of college. The first base income year is the calendar year prior to January 1 of your student’s HS senior year. Anything you can do to prudently reduce reportable income and minimize reportable asset values during these years may be helpful in raising your eligibility. These include deferring bonuses, using home equity to pay off consumer debt (for the IM), using extra savings to pay consumer debt (both FM & IM), using home equity for major purchases like autos, and repositioning taxable investment accounts within IRA’s or other accounts.

Do know parental income is crucial

Parental income in both formulas is the single largest factor in determining aid eligibility. If your earnings are reported to the IRS on a W2 form, you might not have many options, but if you are self-employed or own a business, legitimate and legal methods to lower your reportable income during the college years can help increase your family’s aid eligibility.

Do consider opening a home equity line of credit

Consider opening a home equity line of credit to use to pay for college costs, rather than opting for Parent College Loans. At this time (2012), home equity loan interest rates are very low (under 4%) while PLUS loans are at 7.9% fixed. Though HELOC interest rates are variable, if you manage your repayments well, you might pay much less in borrowing costs over time. Consult with a financial professional to see how these alternatives work within your own budget and circumstances.


Do not let the “financial-aid tail” wag the “family finance” dog

In other words, don’t up-end your entire family financial plan just to qualify for financial aid. You still need an emergency fund and have living needs to pay for during the college years. Remember that Parent Income is often the single biggest factor in the EFC, so don’t spend down all your cash and taxable investment accounts just to get a little more aid. Remember those “asset shelters” in the formulas too! Also, remember that for all but the lower-income families, most need-based financial aid today comes in the form of low-interest student loans rather than free grant money. There still may be some free grants from the colleges themselves, but often that is influenced by the college’s own interest in having the student attend their school versus a competing college.

Do not fall for asset sheltering schemes

There are many so-called ‘college advisors’ proposing that parents “reposition” all of their cash and investment accounts into insurance annuities and life insurance policies to shelter this money from the formulas. Remember that income is a bigger factor than assets generally and of those that are assessed, the actual assessment effectively tops out at 5.65% of the asset’s value, (e.g. $100,000 maximum assessment would be $5,560). Besides, what are you going to use to pay for college if you take all of your savings and hide it in insurance product contracts?

Do not forget your household expenses may decrease

Unless the student is living at home rather than ‘on-campus’, they won’t be using food, utilities, etc while they’re at college. Use this extra cash-flow to help pay college expenses. Most colleges have payment plans to help families finance each year’s costs.

Do not tap into retirement accounts

Tapping into IRA’s and retirement accounts can be disastrous to your retirement future. Not only are you using money intended for your own retirement, but the withdrawals are taxable as ordinary income, adding to your tax burden, and even worse, add to your AGI for financial aid calculations in the following year, thereby potentially lowering your eligibility for aid.

Do not necessarily pay off your mortgage

If your student is considering private colleges, you’re effectively just moving one assessable asset (cash) to another assessable asset (equity). If your student is considering public schools, then this may make some sense, but remember that you’ll need extra money to pay for college costs. While home equity loan interest rates are low lately, there’s still a cost to borrow versus just using cash.

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Understanding how financial aid calculations work for the colleges your student is considering is essential to proper college planning. Each family’s finances are unique. What may work for a high-income family with little liquid assets considering private colleges, may be far different from another low-income, high-asset family considering public colleges. An essential strategy for all college-bound families is to start the planning process long before the student’s senior year in high school. Since the first Base Income Year (where income and assets are counted toward determining EFC) is January of the HS junior year through December of the senior year, planning before this calendar year starts can help the family plan how to maximize their eligibility for financial aid in the coming college years.

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Kevin R. Worthley, CFP®, CDFA™Vice-President, Certified Financial Planner™

Kevin is a Certified Financial Planner™ practitioner and college planning specialist with Wealth Management Resources, Inc., a Registered Investment Advisor, in North Smithfield, RI. He has been helping families of all income levels with college...

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