The FAFSA process discounts the income and assets of students differently than the income and assets of parents in order to calculate the family contribution (EFC) amount. Understanding these components is important to maximizing the financial aid package.
The Government-sponsored financial aid programs are summarized in our blog “Types of Financial Aid.” Need-based Federal aid requires the FAFSA process, while non-Federal aid uses either FAFSA or a more detailed CSS process to determine financial aid offer. Here is the FAFSA timeline.
The application needs to be completed a year before college starts and by using the prior year’s Federal tax return. The financial aid award letter can be expected by the following Spring. A new FAFSA application needs to be completed for each year of college. The FAFSA application is used for determining need-based financial aid the student will qualify for based on family’s finances and college costs.
Financial Aid (FA) = Cost of Attendance (COA) – Expected Family Contribution (EFC)
The COA is published by each college and is the same number for all students. The EFC is calculated from the income and assets of the student and his/her family.
Student’s Income: Half of the student’s income above a certain threshold, Income Protection Allowance or IPA, counts toward EFC.
Student’s Asset: A fifth of all assets in the student’s name counts toward EFC.
Parent’s Income: An Available Income (AI) is calculated from the AGI by backing out taxes paid, Employment Allowance and IPA. Parent’s IPA is based on household size.
Parent’s Asset: 12% of Included Assets above a certain threshold, Asset Protection Allowance or APA, is calculated. Assets included are cash, 529/ESA (see “College Savings Plan”), investments, rentals and business (at a discounted value). Assets excluded are primary home and retirement accounts.
EFC Calculation: The contributions from student’s income and asset are combined to arrive at Student’s EFC. The sum of Parent’s AI and asset contributions is the AAI (Adjusted Available Income). The AAI is multiplied by a factor based on the AAI value and then divided by the number of kids in the college to come up with Parent’s EFC. Family EFC is the sum of Student and Parent’s EFC.
Grandparents’ 529: Grandparents’ assets are not counted towards EFC calculation. But when a distribution is taken to pay for the student’s college expense that will be counted as student’s income in the following year’s FAFSA application. Since, every dollar of student income above IPA reduces financial aid by 50 cents, it is better to transfer ownership of the 529 account to the parent or only take distribution during the last year of college.
Breakeven Example: Our example scenario is a 4-person household including 2 children. The oldest parent is 50 years old. Family AGI is $120K and has Included Assets of $200K. Their total tax is $21K (Federal $9K, CA State $3K, FICA $9K). Let us assume that the student does not have an income or assets in his/her name.
Parent’s AI = $120K AGI – $21K Tax – $4K Employment Allowance – $29K IPA
= $66K
Contribution from Parent’s assets = 12% x ($200K Included Assets – $6K APA)
= $23K
Combining the above two parts, Parent’s AAI = $89K
Parent’s EFC = $9K + 47% x ($89K AAI – $34K)
= $35K
We used the FSA Handbook 2020-21 Table A3, A5 and A6 to calculate Parent’s IPA, APA and AAI Contribution. The COA for University of California is $36K per year for residents who will be paying in-state tuition. Please refer to our blog “College Costs and University Endowment Model” for a detailed view of COA.
FA = $36K COA – $35K EFC
≈ 0
The older child will not qualify for need-based aid in the first year of college. However, if both children are in college at the same time, then their family EFC will be cut in half on each of their FAFSA applications for the overlapping academic years.
We specialize in tax-free retirement strategy and investments such as IUL, Annuity and LTC. Prefer a quick and complimentary consultation? Just email us at Karthik@FinCrafters.com
