New FAFSA Rules Give New Options

14309969 - mini graduation cap on a roll of moneyWith our three girls making their way through school, Jill and I are well aware that our next big family expense will be college expenses. Frankly, it wasn’t too long after our twins were born that the thought of paying for two college educations for the same four years entered my mind. Maeve will be a senior in college when our twins begin; so for one year we will have three in college at the same time . . . yikes!
Over the years, I find that many folks feel that the primary focus of financial planning should be the retirement years. And while the golden years are certainly important and should be a major focus, a truly comprehensive financial plan should help you live a financially secure life well before your retirement years as well.
For guys like me, this means preparing for expenses like college, which has more than doubled since 1986 when adjusted for inflation, faster than the cost of health care, and well ahead of the median family income within the United States.
So today, let’s take a look at some recent changes to Federal Student Financial Aid and the Free Application for Federal Student Aid (FAFSA) for the upcoming academic year, and how those changes may impact our planning process.
First, the rates have changed. Federal Direct Student Loans (subsidized and unsubsidized) to undergraduates with a first disbursement date between July 1, 2016, and June 30, 2017, carry a 3.76 percent interest rate, down from 4.29 percent last year. Direct unsubsidized loans for graduate students issued during the same time frame are fixed at 5.31 percent, down from 5.84 percent; and interest rates on Direct PLUS loans for parents of undergraduate or graduate students, have also dropped, down to 6.31 percent.
Secondly, you can now file your FAFSA in October, prior to the next school year. The FAFSA collects information relative to a student’s assets and income and the student’s parents’ assets and income. A percentage of “countable” assets and income is used to calculate the student’s Expected Family Contribution (EFC) and to put it simply, a higher EFC usually means less financial aid. If your child will attend college starting in the fall of 2017, you can now file as early as October 1 of this year. Also, you will be required to use your 2015 income information. Going forward, students and parents, as appropriate, will be required to use the income information/tax return from the tax year two years prior to the first disbursement of financial aid. Anyone who filed for a child attending school this fall, knows that 2015 tax returns were used for this year as well, so the same information will be used again during this transition year to the new system.
Previously, families used to file the FAFSA on January 1, or close thereto, simply estimating their tax returns, and then would need to update it when they had their real numbers, after their tax returns were filed. The new system allows for faster and more accurate figures for families to plan accordingly.
You might think that your student won’t qualify for federal student aid, but it’s wise to file anyway, as this filing is often a requirement before a student can receive any aid from their chosen institution.
So, with this in mind, how do these changes affect strategies commonly used to reduce the financial stress of paying for college?
Well, one major consideration when planning for financial aid is the timing of income. Remember that a percentage of parental income is “counted” in determining that EFC. Since parents will now be using the tax returns from a year earlier, they need only wait to raise cash (if need be), whether it be by selling appreciated securities or taking a distribution from a tax-deferred retirement account, until the tax year that the student is starting his or her junior year. Previously, it was advised to wait until the tax year that the student was starting his or her senior year before doing anything that would result in increased taxable income. If parents wait until the tax year of the student’s start of their junior year, those earnings will not “hit” their parents’ tax returns until the student’s senior year and won’t be accounted for in any FAFSA filing.
When FAFSA is calculated, the parents’ assets are given much less weight, just 5.64 percent, compared to any assets belonging to the student, 20 percent of which are considered in the calculation of the EFC. This comes into play with 529 plans, since plans belonging to the student or the parent are calculated using the parent’s weight of 5.64 percent. On the other hand, if a 529 plan is owned by a grandparent, it is not a “countable” asset. However, it is important to know that if that 529 plan is owned by a grandparent, any distributions from the plan to the student can be included in the student’s income, which can be counted up to 50 percent. Knowing that there is a two-year delay in countable income for purposes of FAFSA, it can be better to use 529 distributions from parents or student-owned accounts in the first two years, and distributions from 529 plans owned by grandparents in the junior and senior years, to keep the “student” income as low as possible until it is no longer used in the calculation of the EFC.
One last thing to consider is using gift opportunities in a way that won’t factor into the FAFSA equation. As discussed above, grandparents have some options in the last two years of the student’s schooling (again, in the years that income won’t be counted on the FAFSA). Additionally, federal tax law allows unlimited gifts to pay for tuition (even if the gift exceeds the annual gift tax exclusion) if the money is paid directly to the college (other education-related expenses do not qualify for this treatment). However, such a gift may affect a financial aid package offered by the school, so it is important to check on any potential impact before making a gift directly to the school. This strategy can help a student without affecting the EFC calculation and can also be an effective way to transfer wealth by reducing the overall taxable estate without triggering a gift tax.
Another way that grandparents can help, more often with graduate students than undergraduate students, is to gift an appreciated asset, rather than proceeds from the sale of an appreciated asset, to a student who is 24 years old or older. If that student is in a low enough tax bracket (which we expect from students), he or she will not need to pay capital gains taxes on any gains recognized by the sale of such assets. By gifting the appreciated asset, rather than cash, more funds will be available to help the student than if the grandparent sold the asset and had to pay capital gains tax on the proceeds. If the student is under 24, however, the “kiddie tax” will cause those assets to be taxed, based on his or her parents’ tax rates.
Look, college is expensive, and it’s not getting any cheaper, but having a financial plan that incorporates college funding can help minimize the impact of that expense on your future and your kids’ futures. Make sure that your money is working smarter, not harder.
Finally, as I write this column and calculate the potential future expense Jill and I will be facing with three kids in college, I am reminding Susan . . . she has four. Ahh, I feel much better now!