The Wall Street Journal’s Rachel Louise Ensign says families can do a lot to increase the amount of financial aid they receive if they behave strategically.
Ensign identifies (subscription) several common errors:
- Earning too much at the wrong time.
- Letting the wrong family members hold college money.
- Making [incorrect] assumptions about what schools will offer.
- Thinking merit money is all about grades and SATs.
- Not applying for all the aid you’re eligible for.
- Figuring the “expected family contribution” is all you’re paying.
- Going for the loan with the lowest interest rate.
- Thinking an aid offer is set in stone.
- Figuring aid will be about the same all four years.
While some of these errors don’t have strong incentive aspects, others do. In particular, the ability to shift the realization of income across tax years is not something everyone can do, but some people can and doing so increases the amount of discount from full price that a family may reasonably expect:
For instance, take any big windfalls, such as capital gains or the sale of a property,before the Jan. 1 when your child is a high-school junior, says Mark Kantrowitz, publisher of financial-aid website finaid.org. If you own a business, you may want to defer compensation or take a lower annual salary.
“Every $10,000 reduction in income is going to improve your aid eligibility by [about] $3,000” if you have one child in college, says Mr. Kantrowitz. In other words, if you’re the sole breadwinner with one kid in college and cut your pay to $100,000 from $150,000, your child will be eligible for about $15,000 more aid annually. (This is a simplified rule of thumb that doesn’t apply in all cases, he says.)
Still, you don’t want to overdo it. The Internal Revenue Service may come after you for not paying yourself a fair wage, and “the colleges don’t like it when someone is rich but appears poor,” says Mr. Kantrowitz. They may pull back on their institutional aid if they decide your family doesn’t actually need the help.
There also are serious penalties when college-bound kids earn their own money:
[A] child’s income and assets count heavily against their potential aid. Every dollar a child has in assets—that includes bank accounts or trust funds—cuts their possible award by 20 cents. Every dollar a child makes in income above $6,130 (the limit for 2013-14 aid) cuts their possible award by 50 cents.
Uncle Sam might levy a 0% tax rate on their earned income, but this implies that colleges impose a tax rate of 50%. Is there a way around this? Apparently there is, but only if you’re careful:
Before the base income year starts, parents should transfer the child’s assets—that includes any money in checking and savings accounts—into a 529 plan, a tax-advantaged savings account for college, says Mr. Kantrowitz.
Money held in a 529 belonging to a student or custodial parent reduces the student’s eligibility for financial aid only up to 5.64%—meaning an account with $10,000 could knock off a maximum of $564 in aid.
But families should be careful about letting relatives other than custodial parents—like grandparents, aunts and uncles—set up 529s for kids. Every dollar a student gets from a 529 plan owned by other relatives is considered income to the student and reduces potential financial aid by 50 cents if the student is above the income threshold, says Mr. Kantrowitz. A $10,000 withdrawal would reduce aid eligibility by up to $5,000.
College financial aid is a regulated market, so it should not be surprising that both the regulators and the regulated engage in strategic behavior — the latter to minimize regulatory effects, and the former to minimize the ability of the latter to do so.
Such cat-and-mouse games area inherent to the regulatory enterprise. When the costs of college financial aid regulations are tallied, these adaptive responses are ignored.