When considering how to pay for college, several funding strategies may apply. Use of FAFSA, grants, loans, 529 savings plan, and Roth IRAs all play a significant role in paying for a college education.
Free Application for Federal Student Aid (FAFSA)
To learn about how to pay for college, first, let’s look at Free Application for Federal Student Aid, more commonly referred to as FAFSA. FAFSA is the application submitted for federal financial aid for students offered by the US Department of Education. It encompasses federal grants and loans. If a student is independent, no longer considered a dependent for tax purposes, they simply file their information. However, if the student is a dependent, their supporting family member’s information must be submitted along with the student’s and this can make the FAFSA filing more of a challenge. “Students and their families can save time with the IRS Data Retrieval Tool, called DRT, which automatically transfers tax information to the online application”(Powell & Kerr, 2020). Visit the Federal Student Aid website to begin the process.
Who is Eligible?
In addition, be sure to check out the eligibility requirements to qualify for federal student aid. They include financial need, citizenship or eligible non-citizenship, acceptance, or current enrollment in an accredited institution offering a degree, certificate, or credential. Students must also attend school at least part-time.
How is Need-based Financial Aid Determined?
Need-based financial aid is what you can receive if you have financial needs. Once FAFSA is submitted, students and families are anxious to learn the amount and source of financial aid. First, need-based benefit eligibility is determined by calculating the Cost of Attendance (COA). COA depends on the years the student has left to obtain their degree or certificate. Next, Expected Family Contribution (EFC) is examined and this is derived from the information provided on your FAFSA including family income, assets, and any additional benefits received. “Cost of Attendance (COA) − Expected Family Contribution (EFC) = Financial Need” (Federal Student Aid). Need-based financial aid includes grants (which do not need to be repaid) and subsidized loans (which have better loan terms than unsubsidized loans).
Non-need-based federal student aid loans
Along with COA, non-need-based loans also take into account what you have been already awarded based on need. “For instance, if your COA is $16,000 and you’ve been awarded a total of $4,000 in need-based aid and private scholarships, you can get up to $12,000 in non-need-based aid” (Federal Student Aid). Again, non-need-based loan terms may not be as attractive as those awarded for need-based.
529 Savings Plans
In addition, to financial aid like federal grants and loans, college accounts like a 529 savings plan can play an important role in college funding. 529’s are usually set up by the parents or grandparents to benefit a student by helping to pay for college. 529’s are state-run programs. They allow investors to save in a tax-deferred account that provides tax-free distributions for qualified education expenses. Some states allow the investor to take a deduction for contributions made to the account.
Advantages and Disadvantages of a 529
529 accounts are easy to set up and maintain. Most provide age-based models for investing. When the parent or grandparent establishes the account they do so for the benefit of the student who is deemed the beneficiary. With age-based investing, if the beneficiary is young, the account portfolio is more aggressively invested. As the beneficiary approaches college age, the portfolio becomes more conservative in the investment strategy. 529’s have high contribution limits of $15,000 annually. They can be pre-loaded for up to 5 years which allows a $75,000 investment to be made one time within 5 years.
Though a 529 is easy to establish and maintain, provides simplified age-based investing, includes tax-deferred growth, and has high contribution limits, there are drawbacks. To be received tax-free, distributions must be for qualified educational expenses. There are investment fees associated with 529 plans. They also may impact financial aid.
529 Impact on Financial Aid
When considering how to pay for college with a 529 savings account, be careful to determine who will be the account owner. “How a 529 plan is reported for dependent students and counted for financial aid typically depends on the owner of the 529 plan” (Brown, 2016). A 529 owned by the parents for the benefit of the student, represents an investment that may reduce need-based financial aid. This reduction maxes out at 5.64% of the investment value. However, if the grandparents own the 529 plan, this can result in a negative spin. Even though the account is not treated as an asset for Expected Family contribution (EFC) purposes, “withdrawals from the 529 plan are counted as student non-taxable income and up to 50% of the value of the withdrawal could impact financial aid” (Brown, 2016).
Other Self-funding Strategies
In addition to federal grants and loans, or 529 accounts, some families utilize self-funding strategies. Roth IRAs may serve as a useful self-funding investment. Like a 529 savings plan, Roth IRAs have tax advantages too. They grow tax-deferred and withdrawals of contributions are received tax-free. Any unused funds can remain in the account to benefit the owner in retirement. Roth IRAs have drawbacks. Annual contribution limits apply to Roth IRAs. In 2021, the maximum amount is $6000 and if the Roth owner is age 50+ they get an extra $1000 catch up for a total of $7000 annual contribution. High-income earners are not allowed to contribute toward a Roth IRA.
On the plus side, a Roth IRA is not counted toward financial aid; however, withdrawals will be counted as income. Therefore, withdrawing and utilizing Roth funds is better left until the last year of college after income has been reported for acquiring financial aid.
In conclusion, as you plan for college funding, begin by submitting your Free Application for Federal Student Aid (FAFSA). Note the first word of this application is free! If you have allowed enough time to build up a college nest egg, carefully consider which account type is right for your family. 529s are specifically designed for educational savings. Like 529s, Roth IRAs grow tax-deferred and withdrawals are tax-free. However, it is important to consider the timing for use of funds so financial aid benefits are not impacted.
About the Author
Marianne Martini Nolte, Certified Financial Planner ™ practitioner, provides fee-only, fiduciary, independent financial services. Her firm, IMAGINE FINANCIAL SERVICES (IFS) is a registered investment advisor offering advisory services in the State of California and in other jurisdictions where exempted. Marianne’s focus is serving Women and Young Professionals. This article is intended as a high-level view. All written content is for information purposes only. Opinions expressed herein are solely those of IFS, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to other parties’ informational accuracy or completeness.
For more in-depth information, please reach out:
Marianne Martini Nolte, CFP®
Imagine Financial Services
Phone, (760) 472-5155
Brown, T. (2016, May 29). Will your 529 plan hurt your child’s eligibility for financial aid? Forbes. Retrieved September 29, 2021, from https://www.forbes.com/sites/financialfinesse/2016/05/29/will-your-529-plan-hurt-your-childs-eligibility-for-financial-aid/?sh=503e77b23b5f.
Powell, F., & Kerr, E. (2020, October 1). Completing the FAFSA: Everything You Should Know. Retrieved September 29, 2021, from https://www.usnews.com/education/best-colleges/paying-for-college/articles/completing-the-fafsa.
Wondering how the amount of your federal student aid is determined? Federal Student Aid. (n.d.). Retrieved September 29, 2021, from https://studentaid.gov/complete-aid-process/how-calculated#cost-of-attendance.