The 2015 year is winding down. For parents of college bound students and current college students, this is a critical time of the year. Often overlooked in the college process is the creation of a financial aid year-end plan. Listed below are financial items and possible adjustments that should be reviewed before the end of the year. These financial items may help families maximize their availability of college resources. As with any financial decision, these changes should be reviewed with your financial advisor and tax advisors. These are not recommendations but suggestions to consider.
When a family reviews and organizes their financial information early, it allows them to establish a college funding strategy. Most families do not realize that the tax year and school year do not match. This creates confusion since college financial aid planning must happen well in advance of the college application process. By organizing information early, families may be better prepared to take advantage of the various financial aid opportunities.
Many of these financial decisions are orchestrated to maximize your financial aid positioning when you are completing the Free Application for Federal Student Aid or FAFSA. This process needs to be completed each year prior to attending college. It is my belief that every student should submit the FAFSA each year to maximize their resources.
Importance of Income Tax Return
A major component of the financial aid process is the filing of a family’s tax return. The tax return process follows a calendar year and is one of the reasons why creating a financial aid year-end plan is critical. The FAFSA process is now linked to the IRS system through a tool called the Data Retrieval Tool or DRT. Most financial decisions have an income tax reporting event, which will flow through a person’s tax return. Understanding the timing of the financial decisions in the right tax year can have a significant affect on a student’s financial aid position.
The colleges have the ability to override the tax information through an appeal process. This override is called professional judgment. The family will need to submit proper documentation to verify the adjustment. Life events such as: job loss, medical expenses, disability, divorce and other variables can be considered.
What many people do not realize is the financial aid calculation has four separate major calculations. The parents’ and student’s income are driven by the financial information that comes from the tax return. If a family is able to match their tax year with their financial aid submission years, they can increase their abilities to maximize their financial aid position.
Financial Aid Timing
We have often heard people say that timing is everything. In the case of college financial aid this is true. In October of 2015, the Department of Education made a significant change in the income tax timing and FAFSA availability. It is called Prior Prior. Due to this change, both high school junior and sophomore parents need to be much more aware of the 12/31/2015 deadline. With this decision, any financial adjustments made after 12/31/2015 will affect their child’s financial aid position. This change is significant.
After the tax year of 2015, the best time to review a student’s financial aid position will be the tax year when the student is a second semester freshman and a first semester sophomore. For people trying to plan for college, this moves the strategy date up an entire year.
The Prior Prior decision helps to reduce the confusion and stress of the tax information and availability during the FAFSA process. At this time, this decision is only for the FAFSA or federal methodology. Colleges still have the right to request more current tax information when they award their own scholarship money.
(Chart Source: Department of Education)
We often think these adjustments are only pre-college events but they can also be used when the student is in college. For a college student who will be graduating in four years, the Prior Prior has some advantages. Major financial decisions made after the student is in second semester of sophomore year will have no impact on their financial aid. As an example, liquidating stock options to pay for college will have no impact. For this to work it is important to understand that the student has to be at least second semester of college and will be graduating in four years. This is result of the tax year not matching the school year.
As this may be an advantage, you also need to consider these decisions more carefully if you have multiple children and the timing of each decision.
Liquidating Student’s Assets
A big misconception is assets in the student name. As we described earlier, the EFC calculation has four separate calculations that are summed to one number. One of the numbers is student assets. In the calculation, the student assets are weighed at 20% of their value. For the parents, their assets are weighed at 5.64% and have a parent allowance before the value is calculated. For these reasons, many people believe the student should not have any assets in their name. This is not true.
Before you make that decision, you need to know the parts of a family’s EFC. On the EFCplus.com website, we have an EFC calculator to help you through this decision since we break out the parent’s side of the equation. If the parents part of the EFC calculation, which includes both the income and assets, is higher than the colleges cost of attendance on the student’s list then it will not matter that the students has assets listed on the FAFSA.
Here is an example. A family EFC is $44,000. The parents’ part of the EFC number is $40,000 and the student’s part is $4,000. This would mean the student has $20,000 in assets in their name. If the student is only considering schools with a total cost under $40,000 liquidating the student assets will have no impact on the financial aid position. If the student is considering some schools over the 41,000 range than moving the assets may have some impact on the financial aid award.
Before liquidating the account, there are legal and tax issues that need to be considered. If the account has the child’s social security number associated to the account it is legally their money. You need to evaluate if you have the right to liquidate the money and move it. In addition, there may be a tax consequence to the liquidation called the “Kiddie Tax”. Any amount of unearned income over $2,100 will be taxed at the parent’s rate. With both of these restrictions, you need to properly plan before liquidating student account.
529 Plan Review
Most people think that 529 plans are only a pre-college saving tool. Depending on your state residency, using a 529 plan while the student is in college may add some additional savings for a family. Many states offer a 529 contribution tax incentive. A family should review and understand their state’s 529 plan. A 529 plan could enhance a family’s tax deductions and college saving opportunities.
Another great advantage to 529 plans, is they are considered parents assets in the financial aid calculation. By moving assets of the child to a custodial 529 plan, the student assets are now reported under the parents’ asset number. You need to remember that all assets in a 529 plan need to be reported in the parent assets of the FAFSA for all children.
Many parents rush to use the 529 money and overlook other cost saving advantages. Since you are unable to use multiple tax credits with the same qualified tuition expense, many middle income families disqualify themselves for the American Opportunity Credit. This education tax credit is worth $2,500 if you pay $4,000 in tuition, fees, and books. If a family uses only 529 plan money to pay these college expenses then the credit is not available to them. A way to capture the credit would be to pre-pay $4,000 of the 2016 spring semester cost before 12/31/2015. This would allow you to take the credit.
Structuring Student Debt
The proper method of structuring student debt is not understood by most students and parents. Student loans are different than most debt that people take on in their lives. If you consider a car loan or mortgage, a person typically will have one loan with one lender. Since a college education is an ongoing process multiple loans are taken, that have different rules and sometimes various lenders.
A bigger error is parents trying to delay the debt as long as possible and needing to borrow money near graduation. This is why a four-year cash flow should be done at the beginning of the process. By creating a four year plan, families can better understand how to structure the debt the best way.
What most people do not realize is that federal student loans can be very attractive. The federal student loans have various loan repayment options, loan forgiveness, more competitive interest rates and are the legal responsibility of the student. Federal direct loans have an annual amount limit and lifetime limit. If a student does not take that loan in a given year, the prior year loan amount is not available in the current year.
For students who are considering graduate school, reserving undergraduate resources for graduate school may be a great option. By taking the undergraduate loans the interest rate is significantly less than graduate school loans. This strategy is often overlooked in the student loan debt structuring. By completing the FAFSA each year no matter what your financial aid position, the student will qualify for the direct student loans.
The paying for college process is one of the most complicated personal financial decisions a parent will make. Having a plan and understanding your options are critical. Many colleges promote that all of the information is free and you do not need professional help.
These are the same institutions that are producing a national graduation rate less than 40% after 4 years, a transfer rate approaching 35% and student debt over $1.3 trillion. Families need to review their sources of information before making any of the college financial decisions and after thorough research make a college strategy of their own.