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Dangerous Delusion Alert: "Not saving for college maximizes the financial aid package"

Founder & CEO
Wallis is a mom who spent 10+ years at Goldman Sachs as a banker and investor. She founded AboveBoard as a "safe harbor" where people are treated with integrity and can make big decisions with ease and clarity. AboveBoard's interactive Parents' Financial Guide helps you make the right decisions for your family.

A common misconception is that not saving for college maximizes financial aid. 

Like most dangerous delusions, this one contains a shred of truth: the calculation for financial aid does count college savings, so technically a family with college savings will be expected to contribute more than a family that's otherwise the same but has no savings.

But this analysis misses a critical point: the "counting" of savings is so favorable, and the calculation of how much of your income you must pay is so onerous, that saving ahead of time is virtually the only way to comfortably manage.

Believing zero savings will maximize aid also assumes that a student's demonstrated need will be fully met - unfortunately, that is often not the case. 

Let's illustrate with an example. We'll use the Federal student aid calculation (FAFSA).

What FAFSA Will Want From You

FAFSA will come looking for 22-47% of any of your after-tax income above a relatively modest allowance (maximum ~$32,000 allowance for a family of four).

Let that sink in for a minute: imagine paying 22-47% of your after-tax income above a ~$20k-$40k allowance on college education.

Wow.

Now look at how FAFSA treats parents' savings (a 529 plan, Coverdell ESA or regular brokerage account that you open would count as a parent asset).

First, FAFSA ignores your retirement accounts and home equity. (The asset balances, that is...if you withdraw from them, those withdrawals will be treated as income...refer to the 22%-47% above - ouch!)

FAFSA multiplies all the assets it counts by a factor of 12%. Then it applies the 22-47% noted above.

So FAFSA is really it's looking for 2.64% - 5.64% of your counted assets.

So would you rather pay 5.64% or 47%? 

Definitely 5.64%.

You might be like, "but wait, aren't I subject to both?" Yes, you are, but your life will feel much more comfortable when you're able to meet the amount due from your income using the portion of your savings that were not counted in financial aid.

Let's look at how that works.

Example of Why It Really Is Best To Save

Scenario 1: You save nothing outside of your retirement accounts and home equity, hoping to maximize aid. You are a family of two working parents and one child, with household income of $100,000. You live in New York, so FAFSA gives you a little more aid because you're in a high-tax state, but the flipside is you have lower after-tax income (because...high taxes).

FAFSA will calculate your Expected Family Contribution "EFC" (aka the amount they expect you to pay each year) at just over $10,000.

But your after-tax monthly income is about $6,000.

So now FAFSA's looking at you like, "where's your nearly 2 months of after-tax household income for your one child's college expenses?"

And you have saved nothing to cover it. 

Eek. 

There are things you can do: home equity line of credit, parent loans, take an extra job, expect your child to take on more loans (financial aid packages will already include student loans, this would be in addition to that). But none of these options are ideal.

What would happen if you had saved?

Scenario 2: Same situation as above, but instead you'd set aside $300 / month from the time your child was born in a 529 plan (that's about 5% of your after-tax monthly income). Your investment returned 6% / year. Now you've got $112,000 college savings - nice!

FAFSA will calculate your Expected Family Contribution "EFC" (aka the amount they expect you to pay each year) at just over $15,000.

So FAFSA is looking for about $5,000 more per year from your family.

Wait, that's terrible, right?

No, it's actually awesome. Look what happens:

$112,000 529 plan balance / 4 years  = $28,000 / year

You're meeting 100% of your EFC with your savings!

In fact, you have an extra $13,000 / year to be able to tell your child, "you don't need to take those loans that were part of your financial aid package, we've saved enough to cover you!"

That is awesome, that is a great place to be.

Say instead you'd saved less, setting aside $100 / month (less than 2% your after-tax monthly income). Your $37,000 529 plan would result in an EFC of $11,000 / year.

$37,000 529 plan balance / 4 years = $9,250 / year

So now your child is taking on the full financial aid package with loans, and you need to come up with an extra $1,750 ($11,000 EFC - $9,250 529 plan savings) to meet your EFC.

But that's just under $150 / month - VERY achievable, considering your ~$6,000 in after-tax monthly income in this example.

This is still a really nice outcome for you and your child.

The Secret to Why Saving in Advance is Awesome

When FAFSA counts a parent asset at 2.64%-5.64%, FAFSA is saying to you, "we are happy to pretend that 94.4% - 97.4% of your assets don't exist in assessing your ability to pay!"

It's like FAFSA looks at a pile of dollars and says, "let's just pretend those are nickels", then sends you a bill based on the "nickels". But you have dollars to pay that bill. Nice.

Find the right college savings strategy for you and your family with our interactive AboveBoard College Savings Guide.