Saving For College: Best Tips to Maximize Your Aid Eligibility

While most financial advisors market themselves as being able to create a comprehensive financial plan, more often than not, they are completely lost when it comes to saving for college. They don’t understand the FAFSA, EFC, or which assets count and do not count. Saving for college can feel overwhelming, especially with the rising cost of higher education and the confusing landscape of financial aid. The good news is that with careful planning, you can reduce the burden of tuition without sacrificing your financial well-being. In this guide, we’ll show you the best strategies for saving for college. We’ll break down each strategy, uncover the pitfalls of popular methods, and show you how to make the most of your savings while maximizing financial aid eligibility.

Understanding FAFSA and How It Impacts Savings

If you’re planning for college, you’ve probably heard of the FAFSA, or the Free Application for Federal Student Aid. This form determines how much your family is expected to contribute toward college costs, and it’s critical to understand how it works before deciding where and how to save.

The FAFSA calculates something called the Expected Family Contribution (EFC), which looks at your family’s income and assets. Here’s the catch: parent assets and income are treated very differently than your child’s.

• Parent assets, such as savings accounts, non-retirement investments, and real estate (besides your home), are assessed at a relatively low rate—up to 5.64%.
• Child assets, including custodial accounts or savings accounts in their name, are hit much harder, with up to 20% of those funds expected to go toward college costs.

What’s more, income from both parents and students plays a role. Parent income is assessed on a sliding scale, but up to 50% of a child’s income can count against them when calculating aid eligibility.

This is why it’s essential to position your savings strategically to minimize the impact on your EFC. A key tip? Reallocate your assets at least 2-3 years before filling out the FAFSA. Retirement accounts, for example, are not considered in FAFSA calculations, and certain types of savings plans won’t penalize you either.

Why Popular Savings Plans Might Not Be the Best Option

When it comes to saving for college, many families gravitate toward popular plans like 529 accounts, Coverdell ESAs, and custodial accounts. These options offer tax benefits but can hurt your financial aid prospects more than you might expect.

Take 529 plans, for example. These are often touted as a top choice for saving because they grow tax-free if used for qualified education expenses. Some states even offer tax deductions or credits for contributions. However, if a parent owns the 529, the balance is factored into your FAFSA at the 5.64% rate. Worse, if the account is in your child’s name, up to 20% of the funds could be counted.

Other options, like Coverdell ESAs, are similar but come with stricter limits, such as a $2,000-per-year contribution limit and parents can’t contribute if their income is above a certain cap. The cap was $190,000 for the family’s adjusted gross income or $95,000 for a single tax payer. It’s doubtful that the $2,000 a year would even put a dent in a four year education these days. Then there are custodial accounts (UGMA/UTMA), which are legally considered the child’s assets and therefore have a significant negative impact on financial aid eligibility.

Even plans like the Gerber Life College Plan, which markets itself as a way to save for college, don’t offer the flexibility or financial aid advantages of other strategies. While these plans allow for tax-free growth, they count heavily against you when applying for aid. If maximizing grants and scholarships is your goal, you’ll want to steer clear of these options.

The Best Strategies for Saving for College

Now that we’ve covered what not to do, let’s look at the strategies that can help you save smarter. These options not only grow your money efficiently but also shield it from FAFSA calculations, giving your child the best chance at maximizing financial aid.

1. Cash Value Life Insurance

Cash value life insurance is one of the most powerful tools for college savings. Why? Because the money grows tax-free, is accessible through policy loans, and doesn’t count as an asset on the FAFSA. There are no contribution limits, so you can invest as much as you’d like, making it a great option if you’re starting late or have high income.

To get the most out of this strategy, it’s crucial to work with a professional to design a policy tailored for early access. Starting several years before your child applies for aid will give your cash value time to grow, maximizing its potential.

2. Roth IRA Contributions

A Roth IRA might seem like an odd choice for college savings, but it’s surprisingly versatile. Contributions grow tax-free, and while the account is technically a retirement vehicle, you can withdraw your original contributions (but not the earnings) at any time without penalty.

The real beauty of a Roth IRA? It doesn’t count as an asset on the FAFSA. There are annual contribution limits—$7,000 for most people, or $8,000 if you’re 50 or older—but it’s a solid way to save for college while also planning for retirement.

3. 401(k) Loans

Using a 401(k) loan to pay for college can be a viable strategy, especially if you’ve maxed out other savings vehicles. These loans don’t impact your FAFSA calculations, and you have up to five years to repay them. However, this approach carries risks, including the possibility of penalties if you lose your job or can’t repay on time.

If you’re considering this route, try to max out your 401(k) contributions in the years leading up to the FAFSA to reduce your taxable income and further optimize your financial aid eligibility.

4. Grandparent/ Family Owned 529 Plans

While parent-owned 529 plans can hurt FAFSA calculations, grandparent-owned plans are a different story. These accounts aren’t factored into the FAFSA at all, making them an excellent way for extended family to contribute to your child’s education.

Grandparents can contribute up to $18,000 per year without triggering gift taxes, and the funds grow tax-free if used for qualified expenses. Just make sure the grandparent waits until after the FAFSA is filed to make distributions, as those could be counted as income for the student.

Timing and Asset Reallocation Tips

The years leading up to filing the FAFSA are critical. Two to three years before applying, start repositioning your assets to minimize their impact on your EFC.

Focus on moving money into non-reportable accounts like retirement savings or cash value life insurance. Max out contributions to your 401(k), IRA, or other retirement plans, as these accounts won’t be counted on the FAFSA. If you have significant savings in taxable accounts, consider using them to pay down debt, invest in real estate, or contribute to a deferred compensation plan.

Remember, the FAFSA looks at income from the prior two years, so reducing your taxable income during this period is also key. Strategies like bunching deductions, deferring income, or increasing retirement contributions can all help.

Case Study: How Han and Leia Maximized College Savings and Financial Aid

Han and Leia were determined to save for their son’s college education. Like many parents, they sought professional advice to create a solid plan. Their financial advisor suggested opening a 529 plan and a custodial brokerage account for their son, with the advisor managing both accounts for a fee. While these options seemed like reasonable choices, Han and Leia wanted to be sure they were making the best decision for their family.

A Closer Look at the Advisor’s Plan

The advisor’s recommendations offered potential for tax-free growth, but they came with a catch. Han discovered through his own research that both the 529 plan and custodial brokerage account would count as assets on his son’s FAFSA (Free Application for Federal Student Aid). Since FAFSA weighs student-owned assets more heavily than parent-owned assets, this setup could significantly reduce their son’s financial aid eligibility.

Specifically:

• 529 Plans owned by parents or the child would factor into their Expected Family Contribution (EFC) calculation, reducing the likelihood of receiving need-based aid.
• Custodial Brokerage Accounts would be considered the child’s assets, with up to 20% of their value expected to go toward college costs, further limiting financial aid options.

It became clear that while the advisor’s plan might work well for the advisor, it wasn’t in the family’s best interest.

Finding a Better Approach

Determined to find a more effective solution, Han sought advice from another financial professional. This advisor explained how FAFSA works and offered strategies to maximize their son’s financial aid eligibility.

Key Strategies:

1. Cash Value Life Insurance
   • Han and Leia opened a cash value life insurance policy designed for growth. Unlike 529 plans and custodial accounts, the cash value of these policies isn’t reported on the FAFSA. This allowed their savings to grow tax-free without affecting their son’s eligibility for financial aid.
   • They also learned about the ability to take policy loans early if needed, providing a flexible way to pay for college expenses.
2. Grandparent-Owned 529 Plans
   • The advisor suggested involving Han and Leia’s family. A grandparent-funded 529 plan offered the same tax-free growth benefits but wouldn’t show up on their son’s FAFSA, as assets held by grandparents aren’t included in EFC calculations.
   • Contributions were capped at $18,000 per year (to avoid gift tax), but there were no lifetime limits on growth.
3. Reallocating Assets Before FAFSA
   • The advisor also guided Han on how to reposition his income and assets in the years leading up to filing the FAFSA. By maximizing retirement account contributions and moving liquid assets into non-reportable vehicles, they lowered their EFC.

The Outcome

Thanks to the new plan, Han and Leia were able to:

• Save for college with two tax-free growth vehicles that didn’t hurt their son’s FAFSA eligibility.
• Qualify their son for more grants and scholarships, significantly reducing the financial burden of college.
• Retain flexibility with options like policy loans and the grandparent-funded 529 plan to cover any remaining expenses.

Their story highlights the importance of understanding FAFSA rules and seeking advice from professionals who prioritize your family’s financial goals. With careful planning and strategic savings, Han and Leia ensured their son could afford college without compromising his future—or theirs.

Conclusion: Building a Customized College Savings Plan

Saving for college doesn’t have to be stressful. By understanding the nuances of FAFSA and choosing the right strategies, you can ensure your child gets the financial aid they deserve while still building a strong financial foundation for your family.

Start planning early, and don’t hesitate to consult with financial advisors to create a customized plan that works for your unique situation. With the right approach, you can make college more affordable and set your child up for success. Remember, It’s best to use an experienced advisor that does more than just investments and actually knows the best strategies for this objective. Most advisers will quickly give you conflicting advice seeing a possible sale insight and the opportunity to manage your money. If they tell you to open a 529 plan, they obviously don’t know much about saving for college.