Yahoo Finance 4 College Funding Sources -- and How Can They Affect Financial Aid
Parents of college-bound students may fret about the amount of money they've saved for college. But the type of investments they choose also factor into deciding how much financial aid their child will get for school.
That's important because most students need some financial aid for college. Of full-time undergraduate students at a four-year colleges, 85 percent received some form of financial aid in 2012-2013, according to the National Center for Education Statistics.
Many parents approach this topic when they have children in high school and wonder how their investments will work against them, says Scott Weingold, co-founder and managing partner of College Planning Network, which helps students and families through the college admissions and funding process.
"If they'd get started a little younger and known how it was going to affect them, I think they'd be a little better off," he says.
Student-owned assets, for example, reduce aid eligibility more than parent-owned assets do, while some assets aren't counted in the financial aid formula at all. Here's how college savings can affect financial aid.
[Consider these colleges savings trends in 2015.]
1. College savings accounts: Parent-owned 529 accounts are state-operated investment plans for college savings that come with tax advantages. They are considered a parent asset on the Free Application for Federal Student Aid. College savings accounts owned by a dependent student are also considered parent assets. This includes Coverdell Education Savings Accounts, another type of education-specific savings account.
[Search for plans with the U.S. News 529 finder.]
This is good news because parent assets are not penalized as severely as student assets when it comes to determining estimated family contribution, a number used by a school to determine federal student aid eligibility.
"The idea there is that a certain amount of a parent's assets are protected for other things they're saving for, like their own retirement," says Karen McCarthy, senior policy analyst for the National Association of Student Financial Aid Administrators.
Parent assets reduce aid eligibility on a bracketed system that ranges from 2.64 percent to 5.64 percent of the asset 's value, said Mark Kantrowitz , senior vice president and publisher of the website Edvisors and co-author of "Filing the FAFSA , " in an email. Regular savings accounts, mutual funds or CDs in a parent 's name are also parent assets.
2. Uniform Transfers to Minors Act accounts: Student assets, on the other hand, reduce aid eligibility by 20 percent of the asset 's value.
"The reason for that is they assume dependent students don't have other things that they're saving for like parents do," McCarthy says. "And that the primary focus of their assets should be going to their own education.
A custodial account under the Uniform Transfers or Gifts to Minors Act -- known as an UTMA or UGMA -- is a tool that some parents use for education savings because the assets can be used for anything benefiting the child, with some tax benefits. But because they are typically counted as student assets, they have a greater impact on financial aid.
"When the time comes to go to college, those accounts count significantly against them for financial aid, upward of about 20 percent each year," Weingold says.
For instance, $10,000 in an UTMA or UGMA will reduce aid eligibility by $2,000.
3. Retirement accounts: Two major assets are not reported on the FAFSA: retirement accounts and the value of a primary home.
Some families choose to use a Roth IRA to pay for college because the principal can be withdrawn tax-free and penalty-free anytime for any purpose and distributions can be used to pay qualified higher education expenses without penalty.
Keep in mind that the amounts withdrawn may count as income and affect financial aid eligibility for the next year.
4. Income: Before families start moving assets around for more favorable FAFSA treatment, they should know that the financial aid formula is driven more by income than by assets, McCarthy says.
"What I do say, when we're talking about assets -- because I do think that people get very concerned about assets and the impact on financial aid -- is that assets are much less a factor in the whole formula then income is," McCarthy says.
[Understand why saving for college won't kill your chances for financial aid.]
Lastly, while many schools only use the standard FAFSA form, some colleges -- particularly private colleges -- have their own formula for financial aid. Using what's called a CSS/Financial A id P rofile in addition to the FAFSA, they may count home equity or ask supplemental questions about small business ownership or the types of cars parents drive, Weingold says.
"I always tell families, it's a lot more discretionary . " Schools, he says, "can kind of do what they want to do. "
Trying to save for college? Get tips and more in the U.S. News College Savings 101 center.
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