Understanding the Aid Formula
Although every school and scholarship may use its own unique aid formula for the school-based scholarships it provides, they’re all built heavily on the expected family contribution (EFC) model that is used for federal aid programs. EFC is a measure of how much a family is expected to contribute toward a student’s education in any given year.
The EFC calculation itself does not have anything to do with the cost of the college you are attending; it is a separate calculation that is compared to the cost of college you are attending. In other words, someone’s EFC for federal aid is the same whether he goes to Harvard or his local community college.
FLUNK-PROOF FINANCES
Many first-time parents and college students make the optimistic error of assuming that they will receive the difference between their EFC and their cost of attendance. In reality, this “unmet need” is just a starting point for financial aid, with many students not receiving nearly enough to cover it.
For example, let’s say that a family had an EFC (more on the actual calculation in a minute) of $5,000. If their student plans on attending a school that costs $4,000 per year, they’re unlikely to get any financial aid because their EFC actually exceeds their cost by $1,000. However, if their student was to go to a school with an annual cost of $20,000, this amount actually exceeds their EFC by $15,000. So the family will likely receive some financial aid.
In short, the closer your EFC calculation is to the cost of the attendance at the school of your choice, the less likely you are to get financial aid. This means, of course, that one of the primary goals in getting more aid is to legally lower your EFC number as soon as possible and for as many years of school as possible.
Ingredients in the Federal EFC Formula
Because the actual math of the EFC calculation is beyond what a parent or student needs to understand, we’ll just take a look at the main ingredients that go into the EFC formula. The greater the dollar amounts of these individual ingredients that are added to your EFC formula, the greater the ending number and the lower your aid package.
At the core of the federal EFC formula, also known as the Federal Methodology, are the amount of income and the amount of assets a family has in the year leading up to when financial aid is being applied for. Naturally, the more income and assets that someone has, the more she’ll be expected to contribute toward her or her child’s education.
DEFINITION
Federal Methodology refers to the formula used to calculate the EFC for a student for federal financial aid purposes using information from the FAFSA form.
However, not all income and assets are created equal. The assets and income of a student are expected to be used at a greater rate than those of a parent. This is based on the theory that a student does not have many other financial responsibilities, while a parent clearly does. Of course, this is not always true, especially when the student is a parent herself. Further, some assets are completely excluded from the EFC calculation for both parents and students.
A household’s EFC is also affected by the number of people in the household who are going to college at the same time. Although it might be a little too late to whip up an extra child, many creative parents are going back to college at the same time as their kids—thus lowering the EFC for each person and resulting in more overall financial aid for the household.
So, in a nutshell, here is how a family’s EFC is calculated:
A percentage of parent’s unprotected income
+ A percentage of parent’s unprotected assets
+ A higher percentage of a child’s unprotected income
+ A higher percentage of a child’s unprotected assets
= Expected Family Contribution
Dependent Versus Independent Students
Being viewed as an independent student in the eyes of the federal government and by colleges is a huge plus when it comes to the amount of aid a student or family receives. That’s because, as you look at the previous formula, the income and expenses of the student’s parents are removed, resulting in a much lower EFC. But getting classified as an independent student is a lot harder than just turning 18, declaring one’s independence, and getting a place of your own. In fact, most students who move out, get a job, and are financially independent are still considered dependents for financial aid purposes.
To be considered independent, a student must meet one of the following criteria:
• Be at least 24 years old
• Have kids of his own
• Be married
• Be an active-duty military serviceperson or veteran
• Have been declared emancipated by a court
• Be pursuing a graduate degree
• Have other people who are his own dependents (siblings, disabled parents, and so on) living with him
• No longer have living parents
• Have been in foster care after age 13
• Be homeless
If someone does not meet one of these criteria and is truly financially responsible for himself, he can apply for a “professional judgment override.” Under this provision, a school’s financial aid administrator can rule the student as independent; however, this is rarely approved.
General Principles of Increasing Aid
The financial aid formula is far more complex than I can cover in this book. The federal guide to the EFC calculation is 35 pages by itself. So I want you to focus on a couple of general principles that will lower your EFC and increase your financial aid, instead of trying to master the ins and outs of the calculation:
• Principle #1: Shift money to excluded asset categories—In general, any net worth that a parent or child has that is tied up in a retirement account (such as IRAs or 401ks), a whole life insurance policy, or their primary personal residence is not counted as an asset for the federal EFC calculation. For example, you can have a $1 million home that is completely paid off, $1 million in a cash-value life insurance policy, and $10 million in your IRA and not be expected to use any of it toward college under the federal methodology. Of course, shifting money to these assets can result in an increased cost if you have to get it back out, so don’t just stick everything into one of these after reading this.
• Principle #2: Shift assets from children to parents—Because the financial assets owned by a child (savings accounts, custodial accounts, and so on) count much more heavily against the EFC than those of the parents, it can make sense to shift this money to Mom and Dad if it can be done legally.
• Principle #3: Minimize a child’s wasted income—Don’t get me wrong; because the EFC expects you to contribute only part of what you or a child earns toward college, you’re always better off to earn more money than to not. Don’t ever turn down a promotion, a pay raise, or lottery winnings because you’re afraid of hurting your financial aid eligibility. It just wouldn’t make sense to earn $10,000 less to get $2,000 in financial aid. However, if your child has a job and is wasting all her earnings on her own leisure expenditures, your EFC will end up being higher with no extra cash to show for it. If your child is going to work during her senior year of high school or college years, make sure a substantial portion of her earnings goes toward lowering your overall cost of putting her through college because that income she’s earning will decrease the amount of aid you’re eligible for.
CHEAT SHEET
For an in-depth look at increasing your financial aid eligibility, check out The Complete Idiot’s Guide to Financial Aid for College, Second Edition by David Rye (Alpha Books, 2008).
Simplified EFC Calculations
Many people would like to refer to these as rules of thumb, but there are actual provisions that allow a financial aid applicant to use a simplified EFC formula (which does not take into account assets) or even simply claim an EFC of zero. For the sake of figuring out how you’re going to pay for college, you can be reasonably assured that you’ll get substantial federal, state, and institutional financial aid if your EFC is zero or calculated under one of these simplified formulas.
To qualify for an automatic zero on the EFC calculation, a student’s household must have had an income of less than $30,000; not have filed an IRS Form 1040 (only a 1040A or 1040EZ); and either have received federal poverty assistance (food stamps, Supplemental Social Security, and so forth) in the last year or had a dislocated worker as a family member. To qualify for a simplified EFC, which will result in a relatively small EFC, the income limit on these requirements is raised to $49,999 for 2010.
Keeping It Legal
As you evaluate the techniques for lowering your EFC in this chapter, as well as other suggestions that you’ll inevitably hear from peers or find on the Internet, you need to make sure that you don’t do anything illegal. The potential increase in aid you might receive will feel very small compared to a massive fine (as high as $20,000) and potential jail time (up to two years)!
The most common mistake many parents (often encouraged by their advisors) make is trying to somehow “hide” assets or income. They might do this by simply lying on their FAFSA forms about how much they have or make, or they might even go so far as to shift assets illegally or temporarily to unrelated parties in an effort to show a smaller net worth.
What most parents and students don’t realize is that roughly 30 percent of all FAFSA forms randomly undergo verification, which is meant to catch both honest errors and dishonest cheaters. In fact, if you file a FAFSA form four years in a row, there’s almost a 100 percent probability that your FAFSA information will undergo verification at least once.
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