Last week I appeared in an article in the New York Times’ personal finance section about whether saving for college is advantageous or disadvantageous with respect to receiving financial aid. Many people believe that college savings result in lower financial aid awards; it’s a logical assumption since the FAFSA and CSS PROFILE both require students and parents to report their non-retirement assets.

As you probably are aware if you’ve been reading this blog for any length of time, I firmly believe that saving is vastly better than not saving. The main reason that you should save is this: there is no requirement for schools to meet your financial need. And even among those schools that do meet 100% of need, there is no requirement that need be met with “gift” aid, i.e. scholarships or grants. It’s rare to have a need-based aid package that is exclusively gift aid; more often than not, the package includes either work study, loans or both. Furthermore, the FAFSA formula works like this for non-retirement assets:

  • First, a portion of the assets is removed from the calculation via the Asset Protection Allowance. (The exact amount of the allowance depends on the parents’ marital status and the age of the older parent.)
  • Next, the balance is multiplied by 12%
  • That result is added to the parents’ income calculated by the EFC formula
  • The total (available income + contribution from assets) is multiplied by 47% to generate the parents’ EFC

You may have heard the figure that 5.6% of parental assets are considered “available” according to the FAFSA. That’s 47% of 12%. In real dollars, it means that every $1000 of non-retirement assets above the Asset Protection Allowance increases your EFC by $56. Which means that you still have $944 of that $1000 available to help pay for college.

I received a comment from one of the article’s readers that highlights many of the inherent issues in the aid formulas. The writer and his wife started a family later in life. Now that their children are college-aged, they are retired, living off pensions and supplementing that with income generated by their investments. He writes, “… we were unwillingly double dipped by the higher education financial aid formula. We were assessed once for our investment balance at 5% per year. Our dividends and capital gains generated by above mentioned investments were once again considered as income. 50% of this passive income were targeted and same amount of financial aid were taken away. I believe that it is only fair to either assess 5% of my investments or 50% of my dividends NOT both in the same year. Therefore, saving money is not a smart practice for families to receiving future financial aid for higher education. As a family, we should not have lived in a shabby apartment in a low income immigrant community for 16 years to save money, rather we should have moved to a larger house in a better community with a better school district to allow my kids a better K-12 education. Saving money for college is just an excuse that the financial institutions have to earn their fees generated by your funds.”

This situation is unfortunately all too common and brings up a number of issues:

  • As above, there is no requirement that colleges meet your need, nor, if they do, that they do so with grant aid. In the current college environment, where demand for aid far outstrips availability of aid, very few schools do meet 100% of need with 100% gift aid. Not saving, then, generally means being prepared to either take out loans or limit your college choices to those that either meet need or cost less.
  • The financial aid process is a lot like filing taxes. We’re all pretty well attuned to paying attention to taxes when it comes to funding our 401(k)s and IRAs, but unfortunately most people don’t understand the aid formulas until it’s too late. Here is the FAFSA formula. Please pass it along to everyone you know who has a few years to go before college. You have some choices in where to put your investments, and some work better for aid purposes than others. However, in light of the previous point about schools not being under any obligation to meet your need, decisions about where you keep your assets and how you invest need to be considered as part of your overall financial picture and goals.
  • Financial aid comes out of two big “buckets.” Need-based aid is disbursed by the aid office; uses the FAFSA (or CSS PROFILE) as its basis, in particular for awarding federal aid money; and may include loans and work study. Merit aid is disbursed by the admissions office, generally comes from the school’s own funds, and is typically exclusively grants and scholarships. In either case, a human being– whether a financial aid or admissions officer– decides what the student’s actual package looks like, specifically how much is gift versus self-help versus loan. Families with high-ish incomes (income high enough to have some cash flow/ability to save but not so high as to not qualify for any aid) and no college savings might end up with less generous packages in terms of the ratio of loans to grants because the aid officer might see this as someone who had an opportunity to save but chose not to do so.
  • The majority of federal aid dollars come in the form of loans. Pell Grants are the main source of gift aid from the federal government and eligibility for them is quite limited. Federal aid dollars comprise the largest set of funds that financial aid officers disburse at most schools. That means that a need-based package is typically going to include a lot of loans. So, unless you can get your income down to Pell Grant levels, having a low EFC on the FAFSA doesn’t automatically translate to gift aid.
  • Unrelated to the financial aid issues this family is grappling with, I’d like to address the final sentence, at least from my own perspective. I’m a fee-only advisor and a fiduciary to my clients. I do not earn any fees from the funds my clients invest in, nor do I earn any commissions, kickbacks or other compensation from anything I recommend to clients. Plenty of advisors work this way; plenty of others do not. Any time you seek financial advice, whatever the topic, make sure that you get it from an advisor who is a fiduciary to you, not a salesperson for their company.

And I’m going to stick with my recommendation that you are better served by saving than not saving.