Understanding Financial Aid

Over the years, I have developed a network of other fiduciary financial planners. From time to time, I invite one of these individuals to contribute an article of interest. Today, Ann Garcia of Independent Progressive Advisors shares her thoughts about “Understanding Financial Aid” Ann is a financial advisor in Portland, OR.

Understanding Financial Aid

What’s an attribute shared by over 70% of four-year college students? According to Sallie Mae, it’s that they received a scholarship or grant to attend college. With 70% of students receiving some form of gift aid, your student is likely to be eligible for a scholarship too. Understanding how financial aid works will help you to not only maximize the likelihood of being in that 70%, but also to maximize the scholarship dollars you receive.

Financial aid is an umbrella term referring to any third-party funds used to help pay for college. It comes in three main forms: scholarships and grants, loans, and work study. Scholarships and grants are generally referred to as “gift aid” whereas loans and work study are “self-help” aid.

The federal government, through the Department of Education, is the largest overall provider of financial aid. However, when it comes to scholarships and grants, the majority comes directly from the school. Scholarship aid may be need-based or merit-based, and sometimes it’s both. Since they are far more desirable than loans or work study, scholarships are the focus of this article.

Even when the aid is provided by the school, eligibility for need-based aid is calculated using strict formulas from either the FAFSA (for public schools) or the CSS PROFILE (for many private schools). Each of these tools has a formula for determining the Expected Family Contribution based on the parents’ and student’s income and assets. The EFC is compared to the school’s cost of attendance and if there’s a difference—if the EFC is less than the COA—then the student may be eligible for need-based aid. (Pell Grants, the federal government’s primary education grant, are limited to students with very high need; details on that program are here.) Of course, a lower EFC is likely to yield more financial aid.

Merit aid, on the other hand, is used to attract desirable students. Most people think of athletic scholarships when they hear of merit aid. In fact, almost four times as many dollars are awarded annually in academic scholarships as in athletic scholarships, according to scholarshipstats.com. Who’s getting all these scholarships? Typically merit scholarships go to students with high school GPAs and SAT/ACT scores that put them in the 75th percentile and above at schools to which they apply.

The same student might be eligible or not eligible for need-based or merit aid at different schools depending on each school’s cost of attendance and the student body’s academic and demographic profile. It’s up to the student to identify schools that are likely to provide awards. Fortunately, most schools are reasonably clear about whether they provide need or merit aid, or both, so a little homework can help you understand what you’re likely to get at different schools, and an understanding of the FAFSA and CSS PROFILE methodologies can help you lower your EFC and thus hopefully become eligible for more aid.

To determine your likely eligibility for merit aid based on GPA or test scores, just Google your target school’s name with “SAT 75th percentile” (or GPA or ACT). If you’re above the school’s 75th percentile, you’re likely a merit aid candidate. Then, check your schools’ websites to see what sorts of scholarships they offer. Many schools publish scholarship awards by GPA and test scores, so it’s a good idea to check college websites as soon as they get onto your radar screen to see if you’re in the scholarship range.

For need-based aid, families need to know what their EFC will be. You can estimate it using the FAFSA4caster, or get into deep detail using the FAFSA Formula Guide. But filing the FAFSA is a lot like doing your taxes: you can just plug in the numbers and figure out what you owe, or you can try to understand how the system works and make adjustments that save you money. Let’s look at the system.

Each of the aid formulas has four “buckets”: parent income, parent assets, student income, and student assets. Each “bucket” has a formula for how its contents are treated. Parent income is typically the largest piece; its formula goes something like this:
Start with your AGI (from your tax return).
+ Add back your pre-tax retirement plan contributions.
– Subtract your taxes and an allowance based on your household size and number of college students.
x Multiply the result by about 0.4. (It’s a progressive scale that tops out at 0.47 for the FAFSA.)
/ Divide by the number of college students.

Once each bucket is calculated based on its formula, the results of all four are added together to come up with the EFC. The student’s EFC is then used to determine an aid award for the coming school year. A lower EFC will get a larger aid award than a higher one, and there are often planning opportunities that can bring the EFC down. Here are some examples of how you some planning might help to reduce your EFC.

  • Parent income is typically the biggest component of the EFC, so it’s the best place to start adjusting. The main area where most people have control of their income is the state tax refund. Remember, if you get a state tax refund, you have to declare it as taxable income. With the highest parent income assessment rate at 47%, your $2,000 prior year state tax refund will increase your EFC by as much as $940.
  • Parent income is reduced by actual federal taxes paid. In a FAFSA income year (2017 is the income year for the 2019-2020 school year) you want to reduce your deductions. You can do this by pushing itemized deductions into other years, or by contributing to a Roth IRA or 401k.
  • Asset value is reported on the day the FAFSA is filed. While some types of debt are subtracted from assets—margin debt on a brokerage account, for example—consumer debt such as credit cards is not. That means it’s best to file after making all your large payments such as your mortgage or credit card payment.
  • Student income tends to be enough of a lesser factor that it’s overlooked, but it’s the one that trips the most people up. That’s because any money given to the student by anyone other than the custodial parent needs to be reported as student income. And student income is considered 50% available to pay for college. That means that a $10,000 contribution towards college expenses from grandma and grandpa might increase the EFC by up to $5,000.

Aid forms are filed every year that the student is in school, so some advance planning and understanding of the process can help you to time financial decisions and transactions so that you don’t inadvertently penalize yourself. And you aren’t the only one who might change from year to year: before accepting admission to a school when a scholarship offer is the basis for acceptance, be sure to ask what is required to continue receiving the scholarship in future years.