Want to boost your chances for college financial aid? Start early — as in, before your child's sophomore year of high school.
Until your child is a high school senior, you don't have to tangle with the Free Application for Federal Student Aid (aka the FAFSA), the form that determines your family's eligibility for financial aid. But experts say it's worth estimating your aid ahead of time, and employ (legal) strategies to essentially work the formula and make you appear less affluent on paper.
"We spend a lot of time doing all kinds of creative and fancy things to try to reduce their footprint," said certified financial planner Evelyn Zohlen, president of Inspired Financial in Huntington Beach, California.
Upcoming changes require planning even further in advance. Starting with the 2017-18 FAFSA, families can file as early as Oct. 1, three months earlier than the current start date of Jan. 1, using income from the prior tax year. The changes effectively shift the base year of a student's financial aid eligibility a year earlier, from their junior year to sophomore year of high school, said Mark Kantrowitz, vice president of strategy for Cappex.com, a college and scholarship search site.
"That suggests that you have to be careful about artificially increasing income starting January 1 of your child's sophomore year in high school," he said. Asset values are reported at the time you file the FAFSA, allowing more flexibility for last-minute moves.
A few caveats about FAFSA preplanning: Some colleges also ask applicants to file the College Scholarship Service Profile (aka CSS), which uses a different formula. There are also other considerations, including parental marital status, age and number of kids in college, that can shift the formula and affect the expected family contribution.
Some families won't be able to benefit much so it's worth estimating your aid with the government's calculator before making drastic changes. "For the true high-net-worth client, regardless of how they try to manipulate their financial structure, it's going to be fairly difficult to qualify for need-based aid," said Kevin Meehan, a certified financial planner based in Itasca, Illinois.
(Even if you think that's the case, you should still file the FAFSA. Among other reasons, without it, you aren't eligible for any federal student loans and some kinds of state- or college-based aid.)
Making your finances FAFSA-ready comes down to two parts: Assets and income.
Beef up retirement accounts. Balances in qualified retirement plans, including 401(k) plans, pensions and IRAs, aren't reported as assets on the FAFSA. Stepping up contributions in the years before filing, instead of putting money in a reportable asset like a brokerage or savings account, can lower your expected family contribution under the formula, said Meehan.
But proceed with caution. Retirement contributions in a given year get added back as income in the FAFSA — so an 11th-hour contribution won't help. Putting too much into retirement plans can mean you have less that's accessible for other financial goals without early-withdraw penalties, said Meehan. It can also hurt you in retirement.
"If you shove everything into qualified plans … you may have all this money that's tax-deferred for retirement," he warned. "Then when you go to take those monies out in retirement, you have a much higher tax outcome than otherwise. "
Shelter your kid's money. The FAFSA weights assets in the child's name more heavily than those in a parent's name. That's as much as 20 percent, versus a maximum of 5.64 percent for parental assets. The exception: 529 college savings accounts are assessed at the parent rate, even if they are in the child's name.
If your child has money in a savings account or CD he or she has earmarked for college, discuss transferring those to a 529 to get that lower inclusion rate, Zohlen said. (Or, if it's earned income from a summer job, your child might make an IRA contribution so the money won't be counted.)
And if those savings are earmarked for something else, like a car or computer? Try to make that purchase before filing the FAFSA, so the cash won't have to be reported, she said.
Pay down debt. It's a smart magic trick. When you use money from a reportable asset to pay debt that isn't factored into the FAFSA — like credit card balances, an auto loan or the mortgage on your primary residence — it essentially disappears, Katrowitz said.
Paying down your mortgage has extra benefits. The net worth of the home isn't included in the FAFSA, and that equity gives you more options when it's time to pay the college bills, said Meehan — you might open a home equity line of credit. "That's going to be a lot less expensive than going out to get a private loan," he said, and the interest may be deductible.
Assess ownership. If parental assets are better than child assets, assets in a grandparent or other relative's name can be even better. "Now when you go to apply for your FAFSA, you will legally not have to disclose that this account is in your name, because it's not," said Zohlen.
But it's another tactic to approach with caution. Distributions from a grandparent's 529 account may be treated as untaxed income of the student on future FAFSA filings, cutting aid by up to 50 percent.
"This is a terrible backfire," Zohlen said.
Parents have two options to consider. You might reassign ownership of that 529 from a grandparent to yourself, which can be done easily. Or wait until after you've filed your last FAFSA, ahead of your child's senior year of college, to take distributions from a grandparent-owned asset, said Meehan.
Time big tax moves. The FAFSA formula weights income more heavily than assets — at rates of up to 47 percent of discretionary income for parents, and 50 percent for kids — so it's important not to do anything that artificially inflates income during the years under scrutiny. "Absolutely, that's not the year to do your Roth conversion," said Zohlen. "That's not the year to exercise your stock options."
If a big-income year is unavoidable – say, you're relocating for a job and have to sell your home at a substantial gain – you could file an appeal with the college, said Kantrowitz.
"A typical argument would be that your income doesn't reflect your usual income and ability to pay," he said. But some schools won't make that kind of adjustment, and others will do so only if you provide several years' of income tax returns as proof.
Offset capital gains. Tax-loss harvesting can pay off in reduced income under the FAFSA formula, said Zohlen. The IRS allows taxpayers to use losses to offset capital gains, and then deduct up to another $3,000 in a given year.
Minimize income. "Anything you can do to voluntarily minimize your income without putting your lifestyle at risk is worth looking at," Zohlen said. Don't take retirement distributions if you don't have to, for example, or minimize them. Limit investment sales without capital losses to offset them.