Every year students and their parents complete the Free Application for Federal Student Aid (FAFSA). Every year parents wonder, “what’s the point?!” The FAFSA is a tool used by the government to calculate a student’s need for aid when it comes to paying for college. When the FAFSA goes live every October 1st, it may be too late to maximize a student and their family’s numbers. An understanding of a few key points and careful preplanning can maximize your client’s benefit.
1. Understand what prior-prior year (PPY) means.
The FAFSA uses prior-prior year numbers in the calculation. When a high school senior is completing their FAFSA in the fall of their senior year, they are actually applying for aid for the following school year–the year they’ll begin college. In the process, they will use their (and their family’s) most current federal tax information which was filed the previous April (when they were a junior). That tax filing is for the previous year (spring of sophomore year/fall of junior year).
The student and family want to have the lowest income numbers during the tax year that is the student’s spring of the sophomore year in high school and the fall of the students junior year in high school. This is what is called the “base year” and provides the basis for the financial aid package for all four years. Parents might request that a December bonus be postponed until January. If your clients are small business owners they should consider accelerating expenses into the base year. They should try not to sell off investments and so they won’t be subject to capital gains during this year. Better to do that the year before (spring of freshman year/fall of sophomore year).
2. Consider repositioning student’s assets.
In the FAFSA calculation, both the student and the parents report their current checking, saving, and investment values. (Retirement is excluded. 529 plans are included.) Assets in the student’s name are assessed at a rate of 20%. Assets in the parents’ names are assessed at a rate of 5.64%. In addition, a portion of the parents’ assets are protected from being assessed at all (Asset Protection Allowance). Although the APA is going down every year.
The value of the assets will be reported as of the date the FAFSA is completed. (Not a worry for sophomore or junior year!) A minor cannot simply gift the money to their parents. However, they can spend it on their needs–perhaps on things needed for college or ACT/SAT test tutors or a car.
As an aside, do NOT use insurance products to shelter money. They are high premium, low return, fee heavy vehicles that mainly earn high commissions for the ones who are selling them. It can take many years for the cash value to accumulate.
If the student is saving money for college, tap into it at the beginning of their college years and use it up first. Save parental money until the later years. The FAFSA is completed every year. Using up those student assets first will remove that 20% hit from the calculation.
3. Use parental savings to pay off high interest debt.
Parents should consider paying off high interest credit cards, car loans, or make extra mortgage payments. Not only will that lower their total asset value which is subject to that 5.64% we mentioned, but it will also put them in better financial health. Lower debt is always a good thing. (Maybe parents even consider making some larger expenditures like paying for a new roof.)
4. Be exact in your reporting.
Clients should pay attention to what information they are asking you for. They need to read the definitions for what items are included in their investments and what items are not. For example, the value of the house they live in is not included. Real estate that they do not live in counts as an investment. So does a unit in their home that has its own entrance, kitchen, and bath and is rented to someone outside their family. Pay close attention to those definitions to not report more than they should.
Remember, the investment value is the current balance or market value as of the day your clients complete the FAFSA.
For dependent students, 529 plans are reported as parental assets. This includes plans owned by the student and all plans perhaps for other children owned by the parents. If a family has three students with three 529 plans, the balanced for all three must be reported–not just the child who is applying at that moment.
5. Fill out the FAFSA as early as you can.
Need-based aid is first come, first served. The pot of money is only so big. A student should file as soon as possible if they might be a need-based aid candidate.
Qualifying for need-based aid can be difficult, but sometimes a family might be surprised. They may find they qualify at some schools where the cost is high, but the college meets 100% of need. It is worthwhile to make smart financial decisions and plans to do what they can.