FAFSA Income and Asset Protection
In a recent post reviewed the common college funding formula the importance of the expected family contribution. However, many families do not want or know how to create an expected family contribution (EFC) number. If they produce the number, it will likely be a guess. This article discussed allowances and protections in more detail with how they affect the EFC.
Parents and students receive exclusions from the funding formula. Different rates and funding percentages apply to both groups and depend on age. Before we get into the details, let us take a step back and look at the Expected Family Contribution.
Which formula do I use?
Three different formulas exist for the EFC calculation: Formula A for dependent students, Formula B for independent students without dependents other than a spouse, and Formula C for independent students with dependents. Dependent students are the focus of most college planning articles since the majority is graduating high school students or college students who came straight from high school. Dependent students will be the focus of this article as well.
An independent student is considered independent if she meets one or more of the following (1):
- The student was born before January 1, 1994.
- The student is married or separated (but not divorced) as of the date of the application.
- At the beginning of the 2017–2018 school year, the student will be enrolled in a master’s or doctoral degree program (such as MA, MBA, MD, JD, PhD, EdD, or graduate certificate, etc.).
- The student is currently serving on active duty in the U.S. Armed Forces or is a National Guard or Reserves enlistee called into federal active duty for purposes other than training.
- The student is a veteran of the U.S. Armed Forces (see the definition in the box on page 4).
- The student has or will have one or more children who receive more than half of their support from him or her between July 1, 2017 and June 30, 2018.
- The student has dependent(s) (other than children or spouse) who live with him or her and who receive more than half of their support from the student, now and through June 30, 2018.
- At any time since the student turned age 13, both of the student’s parents were deceased, or the student was in foster care or was a dependent or ward of the court.
- As determined by a court in the student’s state of legal residence, the student is now, or was upon reaching the age of majority, an emancipated minor (released from control by his or her parent or guardian).
- As determined by a court in the student’s state of legal residence, the student is now, or was upon reaching the age of majority, in legal guardianship.
- On or after July 1, 2016, the student was determined by a high school or school district homeless liaison to be an unaccompanied youth who was homeless or was self-supporting and at risk of being homeless.
- On or after July 1, 2016, the student was determined by the director of an emergency shelter or transitional housing program funded by the U.S. Department of Housing and Urban Development to be an unaccompanied youth who was homeless or was self-supporting and at risk of being homeless.
- At any time on or after July 1, 2016, the student was determined by a director of a runaway or homeless youth basic center or transitional living program to be an unaccompanied youth who was homeless or was self-supporting and at risk of being homeless.
- The student was determined by the college financial aid administrator to be an unaccompanied youth who is homeless or is self-supporting and at risk of being homeless.
If the student does not meet one item from the listed above, he is likely a dependent student.
Simple or Long Form
Beyond knowing which formula to use, families need to know if they qualify for the simplified formula, long formula, or receive an automatic zero for their Expected Family Contribution, EFC.
To gain a zero EFC, a parent’s income needs to be lower than $25000 and they may file a 1040A or 1040EZ (or they do not file a tax return.) Also, anyone in the household who receives benefits from earmarked means-tested federal programs (Medicaid Program, the SSI Program, SNAP, the Free and Reduced Price School Lunch Program, the TANF Program7, and WIC) may receive a zero EFC. If the parents are dislocated workers, a zero EFC may be obtained.
For the simplified formula, the criteria are similar to the zero EFC but incomes will fall between $25,000 and $49,999.
If the conditions above are not meet, you will using the long formula. For most families, headaches start from this point.
Asset and income allowances
What is the income and asset protection about?
The asset and income allowance provides some relief for the EFC calculation. Certain things like state income tax, income protection, and social security tax reduce a families income and thus the EFC.
However, some items like retirement plan contributions (volunteer employee contributions) are added back into the formula and raise the family’s EFC. Saving for retirement in a qualified account means penalizing you twice for putting the dollar towards another goal. (See question 94 of the FAFSA.) Once, for making the personal choice to not save for education. Secondly, for making retirement plan contributions count towards the EFC. (Watch my blog for more to come on this topic.)
Parent: Income & Asset Protection Allowance
The amount allowed for the parental income protection allowance depends on the number of students in college and total number in the household.
On the first review, the table follows some logic with an increased protection allowance for household size increases. However, as you examine the amounts for protection, the trend seems to move in the opposite direction as the number of children increases.
Two points need to be made on this seemingly negative trend. First, this number helps calculate a families’ total expected contribution. Second, when more than one student attends college, the EFC becomes split over the number of college students. The potential range of expected income a parent may use for the EFC calculation is between 0% to 47%.
Other allowances exist to offset against parents income as well.
US Income Tax Paid- The amount parents pay in federal income taxes decreases the Expected Family Contribution.
State and Other Tax Allowance- Parents reduce the EFC by a stated percentage, based on location and income. See the table below. (not all the states are listed in the table below.)
Social Security Tax Allowance- Like the Social Security tax of 7.65% of income goes towards lessening the EFC on first $118,501 of income. Beyond the $118,501, only 1.45% of income may be used to offset the EFC.
Asset Protection Allowance- Parents receive an asset protection allowance based on income and if the household has one or two parents. The oldest parent sets the protection age and as the parent ages, the higher the allowance becomes. Below, you will find a list of items included and excluded from reporting as shown on FAFSA.gov.
Investments include real estate (do not include the home in which you live), rental property (includes a unit within a family home that has its own entrance, kitchen, and bath rented to someone other than a family member), trust funds, UGMA and UTMA accounts, money market funds, mutual funds, certificates of deposit, stocks, stock options, bonds, other securities, installment and land sale contracts (including mortgages held), commodities, etc.
Note: UGMA and UTMA accounts are considered assets of the student and must be reported as an asset of the student on the FAFSA, regardless of the student’s dependency status. Do not include UGMA and UTMA accounts for which you are the custodian but not the owner.
Investments also include qualified educational benefits or education savings accounts such as Coverdell savings accounts, 529 college savings plans and the refund value of 529 prepaid tuition plans.
If you are not required to report parental information and you own (or if married, your spouse owns) any of these qualified educational benefit plans report the current balance of the plan as a student / spouse asset. The amount to be reported for a prepaid tuition plan is the “refund value” of the plan.
Investment value means the current balance or market value of these investments as of the day you submit your FAFSA. Investment debt means only those debts that are related to the investments.
Investments do not include the home in which you (and if married, your spouse) live; cash, savings and checking accounts; the value of life insurance and retirement plans (401[k] plans, pension funds, annuities, non-education IRAs, Keogh plans, etc.).
Student: Income & Asset Protection Allowance
A dependent student’s portion of the EFC follows a similar process as the parents, but different protection levels exist as noted below.
Income Protection Allowance- The income protection allowance for students is a flat $6420 regardless of family size or how many students in the household are in college.
US Income Tax Allowance- The amount students pay in federal income taxes decreases the Expected Family Contribution.
Social Security Tax Allowance- The same formula is used as the parents to figure this allowance.
Asset Protection Allowance- The EFC formula aggressively uses reportable student assets to fund college. 20% of a student’s assets are figured into the EFC while up to 5.64% of a parents reportable assets may be used. A second major difference between students and parents is the actual limit. Students have a $0 limit on reportable assets that are protected. The opportunity for students focuses on non-reportable assets. 2
As you can see, understanding the mechanics of the FAFSA form become complicated quickly. Piling on the tax side complicates the picture even more. Understanding and working with both forms requires a process like the grafting of two trees. After awhile, it is hard to know where one college planning begins and tax planning ends. This is why working with a Certified Financial Planner who understands both areas adds more value to the college planning process.
- Gather your recent tax returns and FAFSA.
- Make sure all of your data was reported correctly and identify opportunities to further reduce your EFC.
- If the second step becomes too complicated, find a Certified Financial Planner who specializes in college planning.
- Contact me with questions or to set up a one-on-one consultation.