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Does Saving for College Reduce Financial Aid?

This was originally written for and published by Way to the Quad.

Parents regularly express frustration to me, for having been penalized for saving for their child’s education and receiving a smaller aid package.

I’ve actually had some young parents share that their friends have told them not to bother saving at all because they will get less financial aid from colleges.

Should You Save?

The bottom line, from my experience, is that families with savings are better off.  Let’s look at why:

When you apply for financial aid, there is a formula for determining the Expected Family Contribution (EFC). The EFC is the minimum annual amount a college thinks your family can afford to pay for college. You notice how I have underlined and italicized the words ‘minimum’ and ‘annual’.

In 7 years of working with families I have never had a parent look at their EFC estimates and say: Oh, that’s doable. Instead, most parents ask me: Where am I going to come up with that kind of money? They become even more alarmed when they realize that the EFC value they see is not for four years, but for only one year!

Digging Into Your EFC: How It’s Calculated

Only your non-retirement assets are included in the calculation of your Expected Family Contribution (EFC). Non-retirement assets include checking and savings accounts, investment accounts, stock grants – basically anything that is not in a retirement account (e.g., 401k, 403b, IRAs).

EFC calculations consider parents’ non-retirement assets as well as the student’s assets. In the EFC calculation, you are expected to contribute 5.64% of those assets each year to pay for your child’s education. (There are specific allowances that may reduce this amount, but let’s keep it simple).

So, suppose the parents have $100,000 in non-retirement assets (including a college savings account – 529). The EFC formula includes 5.64% of these funds in the EFC calculation which equals $5,640. If the family has not saved any monies outside of retirement accounts this number would be zero.

Let’s assume for a moment that the Jones family had not saved any monies outside of retirement accounts because they believed they would be better off financially since they would receive more financial aid. In this case, their EFC would indeed be reduced by $5,640 per year, which may increase their financial aid.

However, there is a significant problem with this approach.  For most families, the most significant contributor in the EFC calculation of your “ability to pay” is the parents’ adjusted gross income (AGI).

The EFC formula requires you to contribute 5.64% of your non-retirement assets to your child’s education ($5,640 for the Jones family above). However, the EFC formula assumes that you will contribute up to 47% of your total income toward funding your child’s college education! (The EFC formula subtracts taxes and other allowances, so it is not as simple as 47% of your gross, but let’s keep it simple for this example.)

Let’s Look At An Example

As an example, a family with an Adjusted Gross Income (AGI) of $120,000 will have a contribution to their EFC from their income of about $20,000 – $25,000.

Let’s look at the Jones family. 

  • Adjusted Gross Income (AGI) = $120,000
  • Contribution to EFC from parental income = $20,000 – $25,000

I am making assumptions about Federal income taxes paid, family size, etc. This is not meant to be an exact calculation. In this example, the Jones family will be expected to pay $20,000 – $25,000 per year based on income alone. If this family chose not to save for college, they would have no way to cover this portion of their EFC. Their non-retirement assets will increase their EFC, but at the same time they will need funds to pay their share of the cost of college.

I have worked with hundreds of families over the years, and families that have some savings are far better off than families that do not. Families who do not save are forced to rely on less-desirable approaches to cover their EFC, like changing their standard of living so they can afford to pay through monthly cash flow, taking costly parent or student loans, or leveraging other assets. This leads to stressful and difficult situations and decisions.

In conclusion – yes – money that you invest over the years and save for your child’s education will be included in your EFC calculation which will increase this figure, BUT you need to understand that the colleges will calculate your EFC and will expect you to cover a certain amount of the cost of college if you have savings or not.

Want to learn more about college savings, and how to estimate your EFC? Signing up for MyCAP is a low-barrier-to-entry way to get started on the planning process. You can sign up for your free account by clicking here.

Happy Planning!

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