Effective July 1, 2023, the financial aid rules are changing, but financial advisors need to prepare their clients now for the “new normal.” Not only will there be a learning curve for families but there is a financial landmine awaiting unsuspecting parents whose children will overlap during the college years, making college less affordable because of these changes.
In the spirit of equity and access to higher education, the revised approach was really trying to help lower income households by eliminating two-thirds of the questions on the FAFSA (the No. 1 reason cited for notcompleting the application) and increasing Pell Grant eligibility (more free money for those that qualify).
Unfortunately, the new rules and formula still fall short of meeting the needs for a four-year degree program for these families. Certification programs and community colleges, however, will be more affordable because of these changes and offer a real opportunity for training and education that lead to higher paying jobs without burdensome debt.
The new formula, however, fails the middle and upper middle class.
Ironically, the revised approach will limit equity and access for students from these households — the bread and butter for colleges — and widen the chasm between the haves and the have nots. This is why financial advisors must educate their clients sooner rather than later and help families avoid this expensive reality lurking in the details of the new rules.
“This one change will literally double the cost during the years that any middle class or higher-income family has two children in college at the same time. And triple the cost for families that have three kids in college simultaneously.”
This one change will literally double the cost during the years that any middle class or higher-income family who has two children in college at the same time. And triple the cost for families that have three kids in college simultaneously.
The Old and New Math
Under the current formula, when the EFC (expected family contribution) is calculated, it helps mom and dad understand the minimum out-of-pocket cost they are likely to incur for having a student in college. Effectively, it’s a “per household” expense. And when a younger brother or sister joins the college ranks while the oldest child is still enrolled in school, that amount remains the same, effectively being split between the students.
Under the new rules, the EFC is being renamed the SAI (student aid index). The EFC is often misconstrued as the amount of money the family was required to pay, so this is being explained as attempt to clear up any confusion. However, swapping one acronym for another isn’t as benign as it seems, because the formulas differ in very impactful ways.
Instead of representing a household cost, the SAI, designed to serve as an indicator of financial need, becomes a “per student” expense. It multiplies that minimum out-of-pocket cost by the number of students enrolled in college.
A real-world example is the Jefferson family. The parents earn a combined annual income of $140,000, their two kids are two years apart in school, and they’ve saved a little over $20,000 for each student in 529 plans. The family’s EFC is just over $27,000 so when the oldest goes off to college, their advisor would have to help them plan to fund/finance approximately $32,000 per year for six years. (That’s because it’s very rare for a college to meet 100% of the unmet need and parents need to plan on a “buffer” over and above the actual amount calculated.)
Under the new rules, the Jeffersons will need to increase their fund/finance amount to $64,000 during the two years the kids overlap, increasing their total college expense by 33% [$256,000 instead of $192,000.]
More than half of families with two or more children will be affected by this change. About a fifth of these families have one year of overlap, about a quarter have two years of overlap, and 14% have three or four years of overlap.
This change will not make much of a difference in the student aid index for low-income students, but it will significantly decrease aid eligibility for middle- and higher-income students when there are multiple children in college.
“A Real Headscratcher”
The decision to eliminate the benefit associated with having more than one student in college at the same time is a real headscratcher… no reason given, perhaps an unintended oversight, but punishing families in the middle who make too much money to benefit from substantial need-based financial aid.
Many higher education insiders believe most colleges, especially the private universities, will choose to exercise professional judgement and continue to use the current methodology, maintaining the historical relief for families with students that are enrolled simultaneously. There is already a groundswell of support for this decision to be overturned.
Enrollment at large state universities is likely to suffer as an unintended consequence to this change. In trying to make college more affordable for lower income families, the new formula is likely to force middle class and higher income households to seek out “expensive” private universities who use the CSS Profile calculation (which is staying with the current approach of discounting the cost for families with more than one student in college at a time) because these schools will be more affordable.
Attention All Grandparents
The other nuance that is meaningful for financial advisors to be aware of has to do with grandparents funding college. Under the new financial aid rules, grandparent-owned 529 plan qualified distributions will no longer work against a student’s overall aid eligibility. This is a huge win from a planning perspective and will increase the number of 529 plans owned by family members that are not the student’s parent. (Yes, it takes a village to fund a college education today!)
This change is likely to increase the use of grandparent-funded 529 plans because it’s a savvy estate-tax reduction/gifting strategy. Most 529 plans allow for a five-year accelerated gift in a single year.
Under the current rules, a knowledgeable financial advisor would have recommended that a student take distributions from a grandparent-owned 529 Plan starting in the junior year of college. That’s because the FAFSA uses “prior-prior” tax reporting, meaning the impact those distributions would have on financial aid would never show up in the aid calculation (assuming the student finished a four-year degree in four years.
Under the new formula, the grandparent-owned 529 tap can be turned on as soon as the student steps foot on campus because it’s no longer considered part of the aid eligibility equation. That’s a big win and, although a parent-owned 529 plan is only assessed at 5.6% in the EFC/SAI formula, every little bit helps — especially with the multi-student discount disappearing.
In plain English, it will benefit families to send their 529 contributions to the grandparent-owned 529 plans instead of owning it themselves. (It doesn’t have to be a grandparent — an aunt or uncle could own the account).
A Longevity Caveat
A recent client conversation went like this:
“My kids are doing really well — they both have great jobs, good marriages and I don’t worry about them. I do worry about my grandkids, though, and this world they’re growing up in! And the cost of college is ridiculous, even if they do make a lot of money. I think I’d like to help them save for college. How much can I gift to them every year?”
At that point, we discussed annual gifting limits and the fact that they could accelerate up to five years of annual gifting in a single year if the money goes into a 529 plan. It’s important to note, however, that the donor must live all five years for the gift to be deemed “completed.” Should they die before the end of that five-year term, the gift amount that remains is clawed back for estate tax purposes.
This happened to a client of mine who had funded two 529 plans for great grandchildren. She died three years and two months into the five-year term so we had to prorate the gift over 38 months and pull 22 months of the total contribution back into her taxable estate for the 706 tax return.
Still, for higher net worth grandparents this will become a more popular strategy because it will be less about estate tax planning and more about saving and investing for college in a manner that doesn’t hurt the student in the financial aid formulas. It would make total sense to shift 529 plans to non-parent owned plans moving forward based on the new formulas and grandparents would be great candidates for this strategy.
More Changes to Keep in Mind
Divorced Families
The new financial aid rules also change the definition of the “financial” parent in a divorced household and eliminates a loophole that let the parent with the least amount of income take the lead on FAFSA. Going forward, this strategy evaporates and the default moves to the parent with the most financial resources.
Currently, the custodial parent (defined as the parent the student spent more time with/whose address is on record at the high school) is supposed to take the lead on FAFSA. Divorced households with meaningful income disparities often used this loophole: It increased a student’s aid eligibility because the EFC calculation is heavily weighted toward income.
The loophole was also often used by divorced parents who split custody 50/50. This will no longer be an arrow in the college planning quiver and will reflect the financial resources available to the student regardless of where they live.
Income Exclusions
Workman’s compensation and veterans’ education benefits will now be excluded from the FAFSA calculation. If a parent goes out on workers’ comp, this acknowledges that less money is coming into the household and the family is likely to struggle with meeting college cost obligations while the parent recovers
GI Bill benefits can be used for dependents if the service member or veteran properly transfers them. The change in the financial aid rules will protects those benefits and make them even more valuable for these households.
Additional Reading: Covid’s Continuing Impact on College Planning
“Buying college” continues to grow more complex and confusing so it’s imperative we proactively help families make educated decisions about how they approach the significant lifestyle expense associated with post-secondary education. Unfortunately, too many families don’t calculate their EFC until after they’ve completed the financial aid forms – leaving themselves with little to no time to get out in front of this obligation.
Because the majority of families cannot save enough for college, financing remains an integral part of paying for college. Understanding how the new rules create a new reality for families allows us to guide those we serve more effectively.
Beth V. Walker is a wealth advisor with Carson Wealth Management and founder of Center for College Solutions, which is based in Colorado Springs, Colo. She is also the author of the book “Never Pay Retail for College.” She can be reached at bwalker@carsonwealth.com or 719-522-2278.
