By Clark Troy
It’s October again, the days are growing shorter, the nights crisper, leaves are changing colors and falling to the earth, it’s many people’s favorite time of year. But however much we may rejoice in the rhythm of the seasons and the traditions they herald, each year about this time twin goblins await those of us with college-aged kids: the dreaded Free Application for Federal Student Aid (FAFSA) and College Scholarship Service Profile (henceforth the Profile), which determine how much we’ll need to pay to our kids’ colleges of choice.
Let’s review the basics: There are two sets of forms and processes different institutions of higher learning use to evaluate how much families can afford for college: the FAFSA and the Profile. They are similar but differ in important regards. The FAFSA is used by all colleges and universities that might dispense Federal aid (i.e. almost all of them), whereas the Profile is used to determine eligibility for funds belonging to the institutions themselves, which is to say most private universities and a select few public ones, including perennial local favorites UNC-Chapel Hill and University of Virginia. Because, on balance, the schools using the Profile are handing out more of their own money, the Profile digs deeper into the household finances of applicants’ families. While neither application is fun, neither is quite as bad as people make them out to be.
Am I eligible?
The biggest mistake people make is not applying because they assume they earn too much money to get any aid. Everyone should apply, because if an institution wants a student, it often will award “merit-based” aid as a blandishment to get a student it really wants to matriculate, but only if the institution has made sure that there are no Federal programs available for that student. Also, many people just have a misconception about how much money it takes to disqualify yourself from receiving aid. Based solely on income, one can earn up to about $275k before being disqualified from need-based aid at the most expensive and fanciest schools. Just as importantly, if you have a career hiccup and your income is dinged for some reason — say, for example, because of a financial crisis or a pandemic, it’s good to have filed for aid in the past to demonstrate your changed circumstances.
Both the FAFSA and the Profile assess two basic categories for each household: income and assets. Both methodologies take a relatively big bite out of one’s income — i.e. they expect households to contribute a relatively large percentage of their income to pay college expenses — after making allowances for taxes and family size, but they take a smaller bite out of one’s various assets. The two methodologies differ primarily in the types of assets they factor into their equations.
One thing they share in common is that neither of them factor in money you have in retirement accounts: 401ks, 403bs, 457s, HSAs and IRAs of all flavors. This is a most important fact for young parents. Unless you are independently wealthy, you should always save for retirement before saving for college. Though we may not want our kids to be burdened by loans for college, the fact remains that loans are available for college, but not for retirement. Also, if you are diligent in saving for retirement — e.g. by saving the maximum to a 401(k) in the years leading up to college (so $19,500 a year or $26k if you’re over 50) — then when your kids matriculate you can redirect that cash flow toward paying for college. Because you’ve been saving it, you’re used to not spending it. Meanwhile, you haven’t been shooting yourself in the foot by investing your savings in assets that will be gobbled up by your kid’s college.
A key difference between the FAFSA and the Profile is that while the former doesn’t take home equity into account, the latter does. This freaks a lot of people out. “How can I use the equity in my home to pay for college?” they think. The point is, colleges want you to be planning and while they want you to save for retirement, they don’t want people to hide equity in their homes. Also, different colleges will use different formulas for the amount of home equity they take into account. UVA uses none of it, whereas UNC uses all of it, making it theoretically possible that, for a North Carolinian with a lot of home equity but modest income and few other assets, UVA might be more affordable than UNC. In any case, people with kids heading toward college should think very carefully before paying down their mortgages any more quickly than necessary.
As college gets closer, one other important concept people need to grasp is that both FAFSA and the Profile look at “prior prior” years of income. I’ll explain. Right now, people whose kids are applying to (or continuing on with) college are applying for financial aid for the 2022-2023 school year. Because taxes haven’t been filed for 2021, they have to use and submit 2020 tax returns. So the financial aid for a first-year student will be based on her parents’ taxes for the year when she was a high school sophomore in the spring, then a junior in the fall.
This has very real ramifications for people who may have an asset – be it real estate or a security – which has appreciated over time, because the appreciation becomes a realized gain when the asset is sold, and realized gains are miraculously transmuted from assets (which, you will recall, are assessed at a low rate) into income (assessed at a high rate). This means that, if you have an asset you plan to sell to pay for your child’s college, you should sell it before the end of her first semester as a sophomore in high school, so it doesn’t come back to bite you. Alternately, by the same logic, you can wait till her fourth semester of college, after which it won’t hurt you.
Whew. If you’ve stuck with me this far, it shows that you care. There’s considerable nuance to optimizing your balance sheet and income for the purposes of getting need-based financial aid. But, like most things in life, if you inform yourself and plan in advance, you’ll do better.
Clark Troy was born in Durham and educated in the Chapel Hill-Carrboro City Schools, then elsewhere. He is a financial planner at Red Reef Advisors and may be reached at firstname.lastname@example.org. When not working, he reads, plays sports, naps, drinks coffee and plays guitar, not necessarily in that order.