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What counts most in needs analysis?

Your current income is the most important factor in determining need, but other factors play a role, such as your total assets, how many family members are in college at the same time, and how close you are to retirement age.

 

Financial Aid

Financial aid is money distributed primarily by the federal government and colleges in the form of student loans, grants, scholarships, and work-study jobs. Loans and work-study must be repaid (through monetary or work obligations), while grants and scholarships do not. A student can receive both federal and college aid.

Financial aid can be further broken down into two categories: needs-based, which is dependent on your child's financial need, and merit-based, which is awarded on the basis of academic, athletic, musical, or artistic merit.

Most financial aid is needs-based, though merit aid has been making a comeback in recent years as colleges, particularly private colleges, use favorable merit aid packages to attract bright students to their campuses, regardless of their financial need. However, be aware that the availability of college-sponsored merit aid tends to fluctuate from year to year as colleges decide how much of their endowments to spend, as well as the specific academic and extracurricular programs they want to target.

The financial aid impact

The college savings decisions you make can impact the needs-based financial aid process. Come financial aid time, your family's income and assets are run through a formula at the federal level (and at the college level for institutional aid) to determine how much money your family should be expected to contribute to college costs before you are eligible for financial aid. This process is called needs analysis, and the resulting figure is known as your expected family contribution, or EFC.

The difference between your EFC and the cost of attendance at any given college equals your child's financial need. Your EFC remains a constant, but the amount of your child's financial need will vary depending on the cost of attendance at the underlying college. The higher your EFC, the less needs-based aid your child will be eligible for.

Under the federal methodology, student assets are weighed differently than parent assets. Students must contribute 20% of their assets each year, while parents must contribute 5.6% of their assets.

For example, $10,000 in your child's bank account would equal an expected contribution of $2,000 from your child ($10,000 x.20), but the same $10,000 in your bank account would equal an expected $560 contribution from you ($10,000 x.056).

Under the federal rules, 529 plans and Coverdell ESAs are considered parental assets only if the parent is the account owner. This is also true for mutual funds, stocks, bonds, U.S. savings bonds, certificates of deposit, real estate, and any other investment that may be owned by the parent. Exceptions under the federal methodology are retirement plans (e.g., 401(k) plans, Roth IRAs, 403(b) plans) cash value life insurance, and home equity--these assets are never counted, even if they are owned by the parent.

By contrast, a custodial account is classified as a student asset. This means that it is assessed at a higher rate than a parental asset (20% vs. 5.6%).

How much should I rely on financial aid?

Some parents assume that financial aid will do most of the heavy lifting when it comes time to paying the college bills. But the reality is you shouldn't rely too much on financial aid. Although it can certainly help cover your child's college costs, student loans make up the largest percentage of the typical aid package, not grants and scholarships.

As a general rule of thumb, plan on student loans covering up to 50% of college expenses, grants and scholarships up to 15%, and work-study jobs covering a variable amount. But remember, parents and students who rely mainly on loans to finance college can end up with a considerable debt burden. The best thing to do is start saving as early as possible.

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Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not specific to any individual's personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.