Year-End Financial Aid Strategies

There are several financial moves a family can make to increase the student’s future eligibility for need-based financial aid. Since the timing of these strategies can be critical, it is important to review the family financial situation before the end of the tax year and take steps now to better-position the family finances.

Several Years before College

Parents should open a 529 college savings plan and begin saving regularly for their child’s college education as soon as possible. Most families do not save enough for their children’s college educations. As an added benefit, thirty-four states and the District of Columbia offer state income-tax deductions or tax credits based on contributions to the state’s 529 plan. Making a contribution before the end of the tax year can help reduce the parent’s state income tax liability. (In 11 states, the taxpayer must be the 529 plan account owner or the spouse of the account owner to claim the state income tax deduction.)

Review the asset allocation in the child’s 529 plan once a year, to make sure the risk profile of the investments remain appropriate. Rebalance the portfolio if necessary. Generally, when the child is young, the parents should use a more aggressive mix of investments. There is more time available to recover from losses and less money is at risk. When the child will be enrolling in college within a few years, the parents should use a more conservative mix of investments, where there is no risk of loss to principal.

Parents, grandparents and other donors may contribute up to the annual gift tax exclusion without incurring a gift tax liability or using up the donor’s lifetime gift tax exclusion. The annual gift tax exclusion is $14,000 in 2013, 2014 and 2015 for a single donor, twice that if a couple gives together. 529 college savings plans allow donors to contribute five times as much money as a lump sum by using five-year gift tax averaging, a total contribution of $70,000 for a single donor and $140,000 for a couple. The lump sum contribution is treated as though it were made in equal amounts over a five-year period. A loophole allows the donor to have the equivalent of six-year gift-tax averaging. Instead of giving five years’ worth of contributions during the first year, the donor gives a single year’s contribution before the end of the first year. Then, the donor gives five years’ worth of contributions soon after the start of the second year. This yields a lump sum contribution of as much as $84,000 for a single donor and $168,000 for a couple.

Parents should maximize their annual contributions to qualified retirement plans during the years leading up to the child’s college enrollment. It is best to maximize the employer match, since that’s free money. Money in a qualified retirement plan is not considered to be a reportable asset on federal financial aid application forms such as the Free Application for Federal Student Aid (FAFSA). So, maximizing contributions to retirement plans will shelter the money from need analysis.

The student and parents should start searching for scholarships ASAP using free scholarship matching services, such as There are many scholarships that can be won in younger grades, such as a $25,000 scholarship for making a creative peanut butter sandwich, Doodle 4 Google, the national spelling bee, national geography bee and the national history day competition and numerous art, leadership and community service scholarships.

Two Years before College

Eligibility for need-based financial aid depends on income during the base year, which is the tax year prior to the award year. For example, financial aid eligibility for 2015-2016 is based on income during the 2014 tax year.

So, certain financial moves that can artificially increase income should be made two tax years prior to the student’s first year in college, before they will affect eligibility for need-based financial aid. These changes should be made no later than December 31 of the junior year in high school.

For example, assets in the child’s name are assessed more heavily than assets in the parent’s name. One workaround is to move the assets into a custodial 529 college savings plan, which will be treated as though it were a parent asset on the Free Application for Federal Student Aid (FAFSA). But, contributions to a 529 plan must be made in cash, so the parents may need to sell stocks, bonds and mutual funds held in a custodial (UGMA or UTMA) brokerage account. This may lead to capital gains, which can artificially increase income. It is best to realize these capital gains during the year before the base year, when the capital gains won’t count against the student’s eligibility for need-based financial aid.

If the student’s parents are divorced or separated and do not live together, only one parent is responsible for completing the FAFSA. This parent is the custodial parent with whom the student lived the most during the 12 months ending on the date the FAFSA is filed. The parents may wish to change the custody arrangement so that the child lives with the parent who has the lowest income, to increase the child’s eligibility for need-based financial aid. But be careful: if the parent responsible for completing the FAFSA remarries, the stepparent’s income and assets must be included on the FAFSA. It is best for the custody arrangement to be changed at least 12 months prior to the date the FAFSA will be filed.

The College Years

Financial aid formulas are heavily weighted toward income. Starting with the base year, it is important to avoid financial strategies that can increase income, since increasing income can reduce financial aid.

  • Reduce adjusted gross income (AGI) below $50,000 to enable the student to qualify for the simplified needs test, which disregards assets on the FAFSA. If AGI is reduced below $24,000, the student may qualify for auto-zero EFC, which will make the student eligible for the maximum Federal Pell Grant.
  • Minimize capital gains or offset capital gains with capital losses.
  • Reduce AGI by delaying a bonus or capital gain until a subsequent year.
  • Avoid taking a distribution from retirement plans, since a distribution will be treated as part of income, even if it is a tax-free return of contributions from a Roth IRA.

Other strategies involve reducing reportable assets.

  • Maximize contributions to qualified retirement plans. While contributions during the base year will not reduce total income reported on the FAFSA, since the contributions will be reported as untaxed income, the contributions will increase the total non-reportable assets.
  • Spend down savings by paying down debt before filing the FAFSA. Most forms of unsecured consumer debt are ignored on the FAFSA, but assets count against eligibility for need-based financial aid. So, paying down debt, such as credit card debt and auto loans, the family can increase the student’s eligibility for need-based financial aid. Pay down debt at least a month before filing the FAFSA, so that there will be at least one account statement reflecting the change before the FAFSA is filed.
  • One can also spend down savings by accelerating necessary expenses. If the family will be spending money on a new car or roof repairs, it is best for this expense to occur before the FAFSA is filed, instead of afterward.
  • The parents should also spend the child’s assets first, before spending the parents’ money. The child’s money can be used for a computer, summer camp, tutoring and test preparation, as well as college costs.

The parents can also adopt strategies to maximize eligibility for education tax benefits, such as the American Opportunity Tax Credit and Lifetime Learning Tax Credit. For example, parents can prepay next year’s tuition to maximize eligibility for the tax credits. The tax credits are based on qualified expenses paid during the tax year, including qualified expenses that will occur during the first three months of the next tax year. It may be worthwhile to shift these expenses earlier, if the parents will lose eligibility for the American Opportunity Tax Credit next year, perhaps because eligibility for the tax credit is limited to the first four years of postsecondary education or because the parents expect to exceed the income phase-outs next year.

If the student will be applying for college admission, he or she should be sure to apply to a financial aid safety school in addition to the usual mix of reach, match and safety schools. A financial aid safety school is a college where the student could afford to enroll even if the student receives no financial aid from the college. File financial aid applications soon after they become available each year, to maximize eligibility for need-based aid. Don’t miss deadlines.

The family should review their budgeting for college costs once a year, to make sure there aren’t any unanticipated expenses.

After College

After the student graduates from college, the family may wish to consider methods of reducing debt. For example, the student or parents might take a tax-free return of contributions from a Roth IRA to pay down debt, since it will no longer affect eligibility for need-based financial aid. The student can also look into loan forgiveness programs.

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