In a series of recent blog posts, I’ve covered the control and tax issues parents face when determining how to hold assets for their children. Another key consideration I’ll address in this post is how asset ownership impacts need-based college financial aid.

Financial Aid

The first step in applying for need-based financial aid is completing the Free Application for Federal Student Aid or FAFSA. Once you’ve completed the FAFSA, you’ll receive a Student Aid Report, which will include an EFC, or estimated family contribution for college. Colleges use the EFC to determine a student’s financial need, and generally, the maximum aid a student can receive is the difference between the total cost of a particular school less the EFC. So, if tuition, fees, and room and board at State U are $31,000 and the EFC is $22,000, the maximum need-based aid available is $9,000.

Assets are one factor in determining the estimated family contribution, and who owns those assets matters. Up to 20% of assets held by the student are assumed to be available to assist in funding college, while only 5.64% of unprotected parental assets are expected to be used. Parental assets that fall into the protected category that don’t reduce potential financial aid include:

  • Retirement accounts, including 401ks, traditional and Roth IRAs
  • The family’s primary residence
  • A family business with fewer than 100 employees

It’s worth noting that assets held in a 529 account owned by either the parent or the student do reduce financial aid. However, distributions from a 529 are treated favorably from an income perspective in that distributions from the 529 do not reduce financial aid eligibility as long as the 529 is owned by either the parent or the student. Income from 529s held by third parties – such as grandparents – aren’t counted as assets, but distributions are treated as income.

There is a great deal more that goes into calculating the estimated family contribution, but here are a few key takeaways when it comes to holding assets to fund education:

  • In general, assets held by parents will have less of a negative impact on scholarship eligibility than assets held by the student.
  • A Roth can make an interesting vehicle to save for college since Roths fall into the protected category. However, bear in mind that distributions from the Roth to help fund college will be treated as income and thereby reduce the eligibility amount.
  • You might consider transferring assets from your child’s account to your account given that only 5.64% of parental assets (versus 20% of student assets) are counted in determining eligibility. However, the rules for calculating the EFC is complicated, so make sure you understand them before moving assets.
  • Although assets in 529s are included in determining the EFC, the fact that withdrawals aren’t treated as income is a significant advantage that weighs in favor of 529 plans.

Of the three issues that you should consider when determining how to hold assets for your child, the impact on financial aid is typically the most complex. Nevertheless, a general understanding of the issues when coupled with tax and control considerations should give you a good idea of the optimal solution for you when it comes to setting aside assets for your child.