For the first time in about 40 years, some significant changes have been made in the rules for the Free Application for Federal Student Aid (FAFSA). Not all of them are welcome.
Financial planning for college will be much more problematic for middle-income families because many of the benefits that were helpful to them no longer will be.
Under the old rules, families at least got a break if they had more than one child at a time in college. That’s because their expected family contribution (EFC) was divided among these children. Eliminating this break could bode poorly for families with two or more in college.
However, some of the new rules will also offer new opportunities for savvy families to lower their college costs.
Also on the 2024-35 FAFSA, EFC now has a new and less threatening acronym: Student Aid Index (SAI). It still affects how much families are expected to pay for college, no matter what they call it. The new application won’t launch until December, instead of its typical Oct.1 release, which gives extra time to educate clients.
Here’s a sampling of important changes that many families need to know about:
- Parents can now add more to their 401(k) to reduce their adjusted gross income (AGI) without having to add this amount back to their earnings as untaxed income. Utilizing this strategy will make these funds less liquid, which means less cash available to pay for college.
- Parents can also withdraw money from a Roth IRA without reporting it as untaxed income on the FAFSA. However, there are severe earnings and deposit restrictions on Roths.
- Grandparents can now contribute funds directly to their grandchild’s college without those funds being treated as the student’s untaxed income on the FAFSA.
- Untaxed child support is now reported as an asset, not as income. That makes a big difference considering that income is assessed at 47% and assets at only 5.64% on the FAFSA.
- Alimony is only assessed if it is on a parent’s tax return.
The bottom line on income assessments: If it’s not on your tax return it’s not assessable.
Although it might benefit only a handful of clients, the new FAFSA rules result in more low-income and some lower-middle income families being eligible for increases in Pell Grants and a higher-income protection allowance.
Reducing costs starts with your student
Before diving deeper into the FAFSA changes, we’d like to point out that reducing college costs depends on many factors, including a student’s grade-point average and test scores. Even with the growing number of test-optional colleges, a high SAT or ACT score can make a big difference in the size of a student’s merit scholarship.
Students with stellar academic records may also qualify for acceptance at a highly selective university. These schools, with list prices topping $80,000 per year, are less likely to give merit scholarships but are very generous with distributing grants.
Middle-income families earning as much as $125,000 per year often get a waiver on tuition at highly selective schools. Even families with annual income around $200,000 may qualify for some needs-based aid.
Under the new FAFSA rules, tax assessment rates on parents’ assets remained unchanged: 5.64%. Most public and private universities use the federal methodology. Schools that use the CSS Profile formula (referred to as the institutional formula) assess parental assets at 5%.
With the exception of about 25 highly selective institutions, schools will continue to assess student assets at 20% under the federal formula and 25% under the institutional formula. It’s also important for families to understand which asset classes are and are not assessed.
Schools that use the federal methodology will assess the following assets under the new FAFSA:
- Cash accounts (savings, checking, CDs, money market).
- Non-retirement stock and stock mutual fund accounts.
- Bonds (including tax-free municipals and bond mutual funds).
- Custodial Accounts (UGMAS & UTMAS).
- Section 529 and Coverdell Plans.
- Vacation homes and rental properties.
- Small business and farm values.
Reducing funds balances in any of the above accounts can, under the correct circumstances, lower the student aid index (SAI).
It’s possible that Congress may rescind the FAFSA’s addition of small business and farm values. The House’s proposed Family Farm and Small Business Exemption Act is receiving a lot of bipartisan support although public awareness remains low.
But since the assessment rate on business assets is lower than on personal assets, some families may still benefit from moving their personal real estate assets into a business entity. A financial-aid professional can help determine the net benefit in using this strategy.
Under the new FAFSA, the following assets are excluded from assessment:
- Retirement plan assets (IRAs, pension plans, 401(k)s, or qualified annuities).
- Personal items (cars, furniture, etc.).
- Home equity.
- Cash values held in life insurance and annuities.
Though personal items aren’t assessed, this doesn’t mean your clients should run out a buy a new car to reduce their savings assets. But if they do need a new car, it would make sense for them to buy one before they fill out the FAFSA.
They can also shelter funds by paying down their mortgage and increasing their equity in their home. However, homeowners who lack sufficient liquidity to pay for college may need to open a home equity line of credit (HELOC) to access their home equity. Please note, too, that increasing home equity will not benefit families whose children attend schools that utilize the institutional methodology because its formula does assess home equity in its aid calculations.
Life insurance cash values are also a place to legally shelter assets from the FAFSA. Life insurance can be a great strategy, but only if parents work with a fiduciary who knows how to design and structure these complex financial instruments for college funding purposes.
A recent study by Ernst and Young clearly demonstrates that a properly designed strategy, which integrates cash value life insurance and annuities into your overall all financial plan provides significant value to investors. However, you should never use insurance as a strategy only to shelter assets from the FAFSA; it should also provide clear benefits to your overall financial plan.
The Institutional Methodology
Some of your clients may need guidance on the CSS Profile if their children are applying to or attend colleges that utilize this institutional methodology. The rules are a little different than the FAFSA rules. Here’s what’s assessed:
- Cash accounts (savings, checking, CDs, money market and other cash on hand.)
- Non-retirement stock and stock mutual fund accounts.
- Bonds, Including tax-free municipals.
- Custodial Accounts (UGMAS & UTMAS)
- Section 529 and Coverdell Plans (uncertain if will follow FAFSA rules)
- Vacation homes and rental properties
- Small Business Value (will not be rescinded)
- Home Equity (Assessment rates will vary from college to college)
- Assets held in sibling accounts
With few exceptions, home equity will also be assessed. Accordingly, a family with $300,000 in home equity, may end up paying an additional $15,000 a year ($300,000 x 5%), or $60,000 over four years for college. Since this information is not available on each college’s website, families will need to find out the details directly through their financial aid offices.
Although the cash value of insurance is not assessed, cash held in nonqualified annuities must also be reported and counts as an asset under the institutional methodology. This amplifies the importance of only engaging fiduciaries who understand the financial aid system.
Top of mind
The elimination of the multi-child “discount” is going to be the biggest shock or disappointment for families who have or will have more than one child in college at the same time. Their only recourse is to use the appeal process.
We always encourage families to take the time to learn how to appeal and, to even negotiate for additional aid with their top-choice college. A strong appeal can take many thousands of dollars off the cost of educating your children.
Jack Schacht is the founder of My College Planning Team, based in Chicago. Jim Kraiss, CFP, is the president of Financial Fulfillment, Inc., based in Wheaton Ill. Jim’s expertise is designing non-assessable financial instruments for college funding.