Need-based financial aid awards for college don't just depend on a family's income. Students' eligibility for such aid could be decided in part by how much families have saved for their education, including in tax-advantaged 529 plan accounts.
That's because schools use a number called the expected family contribution, or EFC, to determine how much a family can afford to contribute to their child's education.
Varying formulas are employed based on whether a school uses a number calculated according to a legally established formula, with the income and asset information provided by the student and parents, on the Free Application for Federal Student Aid, or from data in the College Scholarship Service (CSS)/Financial Aid Profile.
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That figure is compared with the cost of attendance by schools to determine a student's eligibility for need-based aid. Families generally get less aid as their expected family contribution comes closer to the cost of attendance.
Fred Amrein, a Pennsylvania-based personal financial adviser, says that in a family where the parents have a gross income of $160,000, their expected contribution – based on a number of factors such as the state they live in – is $39,500.
Generally, need-based financial aid can only be awarded up to the cost of attendance. In this example, if a child plans on going to a school where the cost of attendance is $30,000, the amount of savings wouldn't matter because the family's expected contribution based on income alone is higher than the cost to attend that school, he says.
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However, if the student plans on going to a private school with an annual cost of attendance of $50,000, the family's assets will matter, he says.
Take a different example. If a family's income is not enough to meet the expected cost of attendance but the parents had a lot saved for college, those savings would be a greater factor in their expected contribution.
Age matters, too. Parents' 529 plan accounts and other savings count toward the EFC on a weighted scale based on the oldest parent's age, says Amrein. The older parents are, the less these funds factor into the expected contribution.
If the parents in the first example are 48 years old and have $80,000 in countable assets, their $39,500 expected contribution would increase by $2,100. Countable assets generally are taxable assets with the exceptions of home equity, small businesses and 529 plans. Retirement accounts do not count, Amrein says.
Keep in mind that a student's income and savings play a role in the calculation as well. If the student earns less than the standard tax deduction – $6,100 in 2013 – that income would not be expected to be a part of the family's contribution to the cost of college.
If that student had $10,000 in a savings account under his or her own name, about $2,000 would be added to the expected family contribution – nearly the same amount added by the parents' $80,000 in assets. Therefore, this family would have been better off saving for college in a 529 plan or savings account under a parent's name, Amrein says.
To plan ahead, students and parents can use the FAFSA4caster tool offered by the Department of Education. This tool gives parents the opportunity to plug in different variables such as asset levels and income to see how their expected contribution changes.
Parents could see what happens to their EFC if they save more in a 529 plan or if they deposit money into their child's savings account. They can also see what will happen to their expected family contribution if one parent receives a raise at work, says a spokeswoman for the Department of Education.
But a student's total financial aid package isn't just dependent on need.
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"The expected family contribution as calculated from the FAFSA data is used to award need-based financial aid," says Jim Brooks, financial aid director for the University of Oregon. "However, merit-based aid is typically awarded based on academic performance alone."