The Impact College Savings Has On Financial Aid
investing-my-money | Read Time: 3 minutes
By Donald Lyons, CFP®, NSSA® | Published: February 2023
February is Financial Aid Awareness Month, created to provide parents, students and families with the education and resources to make the most effective decisions as it relates to financial aid. Every year parents and students are required to complete the Free Application for Federal Student Aid, or (FAFSA), to determine their eligibility for student financial aid, which comes in the form of grants, scholarships, student loans or work study programs.
The average cost of college in the U.S. is $35,551 per year (1) and rising, which has placed an enormous strain on household budgets, finances and retirement plans. As a result, parents and grandparents alike are aggressively saving for college through 529 plans, Coverdell Education Savings Accounts (ESA) and Uniform Transfer to Minors Act/Uniform Gift to Minors Act or UTMA/UMGA accounts.
Here is the impact that these savings vehicles may have on financial aid.
The Expected Family Contribution (EFC)
The EFC is an estimate of how much a family can afford to contribute toward college expenses. It’s driven by a family’s income and assets as reported on the FASFA. Families with higher incomes and assets will have higher EFCs and be expected to contribute more toward college expenses (think less financial aid), while families with lower incomes will have lower EFCs and be expected to contribute less.
UTMA/UGMA allows custodial accounts created by adults (parents) for the benefit of a minor (their child). It provides the widest array of investment options such as stock, bonds, mutual funds, ETFs, etc. However, once the child reaches the age of 18 or 21, depending on the state, they take full possession of the account. Funds within a UTMA/UGMA can be used for anything, college expenses, car purchases, etc.
Outside of the kiddie tax ($2,300 in earnings or greater depending on parent’s tax rate) there are no significant tax benefits. While there is no maximum amount a parent can invest through an UTMA/UGMA, any amount above this year’s annual gift tax exclusion ($17,000 for single, $34,000 for married) will require an additional IRS filing. UTMA/UGMAs are considered an asset of the child, which means 20% of its value will be counted as part of the expected family contribution (EFC) or the amount a family is expected to contribute toward college.
Coverdell Education Savings Account (ESA)
Also known as an Education IRA, Coverdell ESAs work very similar to IRAs in that they are tax deferred accounts, but they are used for college expenses. They provide a wide array of investment options such as stocks, bonds, mutual funds, etc. However, the maximum annual contribution limit is $2,000. The income requirement also limits who can contribute to a Coverdell; a single person and married couple’s income cannot exceed $110,000 and $220,000, respectively. Coverdell ESAs can only be created for children aged 18 and younger. In addition, funds must be used before age 30. Coverdell ESAs are considered a parental asset and will only account for 5.64% of the EFC.
529 College Savings Plans
By far the most popular savings vehicles, 529 plans offer tax deferred growth with deductions at the state level depending on the state. Investment options are limited to just mutual funds within the plan, however, 529 plans are structured in such a way that almost anyone can contribute. Contributions are tied to the annual gift limit not considered gifts and not taxed. They also allow for super funding; anyone can contribute five years of gifts at once. This would be $85,000 and $170,000 for single and married couples, respectively. Not only can funds be used for college educational expenses, but they can also be used for K-12 expenses ($10,000 per year), student loans and with the passage of the Secure Act 2.0, retirement savings. Considered a parental asset, their value only accounts for 5.64% of the expected family contribution.
Saving for college education is important but not always easy, so be sure to consider it in your financial planning discussions with your certified financial advisor.
Reference: 1Cost of college: https://educationdata.org/average-cost-of-college
About the Author – Donald Lyons
Donald Lyons is a Wealth Strategist with Bryn Mawr Trust. With 20 years of experience in wealth management, he provides high-net-worth clients with fiduciary and investment management services. Donald provides comprehensive financial planning focused on income replacement, asset management, incapacity, and estate planning. He also has experience working with endowments, foundations, and other nonprofit institutions.
Donald is a CERTIFIED FINANCIAL PLANNER™ professional.
This communication is provided by Bryn Mawr Trust for informational purposes only. Investing involves the risk of loss and investors should be prepared to bear potential losses. Past performance may not be indicative of future results and may have been impacted by events and economic conditions that will not prevail in the future. No portion of this commentary is to be construed as a solicitation to buy or sell a security or the provision of personalized investment, tax or legal advice. Certain information contained in this report is derived from sources that Bryn Mawr Trust believes to be reliable; however, Bryn Mawr Trust does not guarantee the accuracy or timeliness of such information and assumes no liability for any resulting damages.
Are You Ready for the Recent Retirement Enhancements from the Secure Act 2.0?
In December 2022, Congress passed the $1.7 trillion Consolidated Appropriations Act to avert a shutdown and fund the federal government for fiscal year 2023. Attached to this 4,126-page bill is the Secure Act 2.0, which changes retirement planning as we know it.Read More
Is a Roth IRA Conversion Right for You?
As we begin a New Year, we often reflect on the past and make resolutions for the future. Last year brought many challenges within the overall financial markets. In an effort to fight inflation the Fed raised interest rates from near zero to a range of 4.25% to 4.5%, the fastest pace since the 1980s.Read More
Key Steps for Successful Financial Planning
Even the most ardent savers question whether they are doing enough to achieve financial success. Regardless of where you are on the spectrum of planning and saving for your financial future, now is a great time to focus on your finances.Read More
For Retirees, Some Welcome Social Security and Other Benefits Increases to Help Ease Impacts of Inflation
With inflation at multi-decade highs, retirees are feeling the squeeze as they grapple with the effects of rising prices on gasoline, housing, medical expenses and groceries, to name a few. With the Federal Reserve aggressively fighting inflation by raising short term interest rates, both the stock and bond markets have experienced substantial declines, adding further stress to an already stressful environment.Read More
Year-End Tax Planning Checklist – Steps to Maximize Your Financial Plan
Before the year comes to a close, there are some things you should review and consider with your overall financial plan. This past year has brought challenges such as inflation and a weak market performance, and with rising interest rates and new legislation now may be the best time to make adjustments before 2022 ends.Read More