kitchen table math, the sequel: Real World Math Problem

Tuesday, March 17, 2015

Real World Math Problem

FAFSA's EFC is based on your gross before-tax income (including IRA and 401K contributions) and your excess assets. You are expected to save some of your after-tax income to pay for your child's education. During the year, you cut back and save as much as you can. However, when you fill out the FAFSA form, this after-marginal-tax bracket money is sitting in a non-retirement account and is used to increase your EFC. However, if you get a tax refund that comes in late, then it's not sitting in your account and you do not have to report it. Likewise, if you get a bonus (which is income) that comes in on July 1 and you use it to pay for college, it will not be sitting in your account when you fill out FAFSA following year.

One college accounts for this for student income because the percentages are high, but the comment was that this was "small" for parents. My son's college uses 8% after taxes and we're not talking about a meal at IHOP.

The no one right answer math question is: "What's up with that?"

Also, if you take IRA money out to pay for college, then that's added to your income and used in next year's EFC. Score one for Roth.

What's up with that number two?

In our case, our tax refund came in after FAFSA and before CSS Profile. I think I will take out a whole lot more in taxes and not file electronically.


Anne Dwyer said...

We are just at the nerve racking part of waiting for those last acceptances (or not) and waiting for all the financial aid info to come in.

I recently got a windfall from a job I worked for 2.5 year many years ago. When the company was sold, I was vested in the pension. I got a letter last year asking me if I would like the cash value of this pension. Absolutely. So I rolled it over into my IRA and plan to use if for my daughter's last semester of college when I don't have to worry about the extra income counting against financial aid.

ChemProf said...

The whole system of "tell us what you make and we'll tell you what it costs" is a racket. When I went to school, house equity was actually included in money available to pay for college, which was a huge issue in California. With two government-worker parents who bought their house in the 1970's, I qualified for nothing. And it's really unclear that saving for college is a good idea, since they take that money first.

SteveH said...

Our CSS Profile-based formula has three main factors; gross income based on a sliding scale between $60K and $200K, non-retirement assets over an "asset protection" level that varies with age, and a factor applied to excess equity in your house. In general, savers and older parents with higher income and more equity in their houses are hurt more. Some set different excess and cap levels for your house equity, but counting that presumes that you will take out a loan based on your house's equity to pay for college. If you are older and trying to pay off your house, this is not helpful.

You are also expected to use the money you are putting into a 401K or IRA for college because they count that in their formula as part of your income. Again, if you are nearing retirement, this is not helpful. It's not helpful at any age. If you then try to avoid remortgaging your house by saving more from your income, then that money is counted twice. If you take out less for your 401K and set that aside for college expenses, you will have to pay tax on that and it will be counted as assets and charged twice.

Taking out equity from your house will make you look poorer for the house asset (assuming that you are over that level), but you will have to immediately start paying on that equity loan. However, the loan should be less that 5% (at this time), you can deduct the interest, and you can take it out right before you have to pay the bill. If you have that money sitting in a non-retirement account, colleges will increase your EFC by 5-8% of that amount each year. They expect you to go into debt one way or another. If you save from your income, you will be charged twice, but if you take out equity loans, you will look poorer and not have extra cash sitting around waiting to be counted.

Don't save for college. Put it all into retirement accounts or take big vacations. Make yourself poor. Then try to make up for it afterwards.

Anne Dwyer said...

Yikes! What a mess.

Do you know if/when they do an actual look at your finances to see if you have more than $36000 in your accounts? We are over that now but only because we use an AMEX card that we pay off every month and because we haven't paid our federal taxes and our estimated taxes for Q1.

Some of the money in those accounts are not 'savings' but just sitting there until a bill comes due. For example, our property taxes are due twice a year. I don't have an escrow account with my mortgage so I have to keep my own escrow account.

The formula for financial aid has always been an issue. I am the last of five kids. My dad worked for the government and we were a one income family for a long time. Still my parents refused to fill out the FAFSA because they knew that they would not get any money.

SteveH said...

FAFSA asks for the total amount in your checking and savings accounts on the day that you file. Last year, we paid off the loan on a car in January. They don't count credit cards, so you should pay them all off if you are above the asset protection level.

They don't ask to see copies of your checking and savings accounts, but they could. I'm no expert and I assume that all parents run into this problem - either to pay off as much debt beforehand or don't include it because they are going to use it to pay specific bills soon, like property taxes.

This is a cash flow issue and I assume that colleges expect you to play the game. However, cash flow variations can be very large for some people, especially if its cash saved from income to be used to pay for college. We are older and don't want to use our equity line of credit and we don't want to stop contributing to our retirement accounts - things they EXPECT you to do, so we try to save very hard to get as much of the bill from income, which is already counted. This is not trivial change and it's not really an "asset" to be protected. Therefore, this money is used to raise our EFC by 5-8% of that money.

Colleges know that families have huge variations in cash flows but I see no advice from them. If you find it, let me know. When I told an attorney friend of mine (who has the last of four kids in college) that I thought I would withhold a lot more money from our taxes and then not file electronically so that we got a huge refund in May, he said: "That would work." He also said that he would not include the tax refund we got after filing FAFSA in our CSS Profile filing. We couldn't really ignore the bonus my wife got in January, but that could have come in July.

I consider cash flow variations to be a fundamental flaw in the process. If they think it's relatively small money, then I want them to just give me a few thousand dollars because it's really small compared to their endowment.

House value is another game to play, but I felt it was safer to just use our current assessment and not worry about it.

Few get no benefit from FAFSA or CSS Profile because the list price is so high. It's a classic case of having a really high list price and trying to make you feel better by giving you some throw-away discount - and making you go through financial torture each year to get it.

SteveH said...

There is also the problem for need-only colleges where if you get more than a certain amount of outside scholarship money, they will reduce your need award dollar-for-dollar. If you apply for many scholarships because you don't know which you will get, there is the possibility that you will take money away from another local student and have to give it to your college without getting any benefit.

Anne Dwyer said...

I consider my husband and me semi retired because he is collecting a pension and neither one of us work full time. We are also no longer contributing to our retirement accounts. But we both work 1099 so on April 15, we will owe federal taxes as well as Q1 payment.

My daughter has a college fund in her name that will pay for one year or a little more depending on where she goes. We have already saved enough for year 2, that's why there is so much in the savings accounts.

I just always assumed that she would not get any money unless she got into one of the Ivies or she managed to get some type of needs blind scholarship. If she doesn't get anything this year, I don't need to fill out the FAFSA anymore.

We have always told her that we want to graduate college with no debt and that we would help her do this.

Anne Dwyer said...

Here's another interesting math problem: my daughter is thinking about going to McGill University. The cost for an international student is reasonable but the cost is in Canadian dollars. So the costs fluctuate with the exchange rate. And you have to factor in the fees for paying the tuition.
But she won't be getting any financial aid so I won't ever have to worry about filling out the FAFSA again.
I can't agree with the advice to make yourself poor. Maybe you were being ironic, but it would be too stressful for me.
When I started saving for my kids college education, my assumption was that they would get no financial aid. I figured (and I think my experience with the whole college process supports my assumptions) that unless my kids were able to get into an Ivy, I would be paying full freight to a state school. The international option did not occur to me, but it seems to be a good one.
We started saving before 529 plans so we used the United Gift Trust to Minors. Most professional advice says not to do this because it is counted heavily against them for financial aid and they take possession when they reach 18.
But it worked well for us because my son has disabilities and did not go to college. I did not want to be locked into one type of vehicle. No one knows what the future will hold. I wanted to be as flexible as possible.

Froggiemama said...

Over the last 10 years, I know SO MANY people who have sent their kids overseas for college to save money. Mostly it is McGill (I know 5 different people whose kids went there from the US), but also Trinity in Dublin, and University of Edinburgh. It is definitely an avenue to explore

Anne Dwyer said...

Froggiemama: thanks for the comment. My daughter went to visit McGill and absolutely loved the school and Montreal which has a walk score of 97.

If your friend's kids have any specific comments on going to McGill, good or bad, I would love to hear them. It really looks like she is leaning that way.

Anonymous said...

Here is my naive question: two weeks before you fill out fafsa, is it cheating to send a several-month sized prepayment to your credit card company?

SteveH said...

"Maybe you were being ironic,"

Yes. We've finally paid off our mortgage and we continue to max out our 401k, but college formulas count your IRA/401K savings and your excess house equity. They expect you to stop saving for retirements and to take our loans against your house. So we try to save as much from our income as possible. We cut back completely, but then that money is sitting in our non-retirement accounts now that it's FAFSA/CSS Profile time. That money is being counted twice.

I also agree with checking colleges outside of the US. I have a niece currently at Edinburgh.

SteveH said...

"...two weeks before you fill out fafsa, is it cheating to send a several-month sized prepayment to your credit card company?"

No. We paid off all of our credit cards and remaining car loans last year in January. They only ask for your account balances on the day that you fill out the form. They know that cash flow varies quite a bit and they know that the name of the game is to minimize the numbers in their formula.

However, the cash differences can be great if you have $25K+ sitting in an account waiting to pay the college bill versus waiting until the last second to take out the full payment from your home equity line of credit. That also has the benefit of making you look poorer next year. Doing that one thing removes up to 8% of that value this year from your EFC and also reduces your EFC by the same amount every year thereafter. Each year you take out more loans, the lower your EFC.

That is a good way of paying for college. If you have excess equity in your house and can get (a typically low) home equity line of credit. Excess home equity has the same factor in the EFC formula as your excess non-retirement assets. Instead of saving from income to pay for college and have that money counted twice, you take the money from your line of credit and pay that loan off from your income. You then don't have that income sitting around, you look poorer next year, and you get to deduct the mortgage interest. Look at it this way. If you don't take out the loan, then that income money (already counted once) is counted again at up to 8% because it is now an asset, but your equity loan will be at a much lower interest rate.

There is also the method I came up with that has you withhold a large amount of money from your income and then file as late as possible non-electronically so that your huge refund comes well after filing FAFSA.

However, we are not doing this. It is anathema to us to increase our home debt just to minimize our EFC. It's a corrupting formula that causes many to do things financially they really don't want to do. It causes many to find any dubious way justify a lower market value for their house. We didn't do that and we have income that is being counted twice.

Froggiemama said...

All the people I knpw whose kids went to McGill said it was a good decision. The kids all loved the place. One thing to consider though - in 3 of the cases, the kid stayed in Canada after graduation, and one even married a Canadian. That isn't a bad thing, IMHO, but it is something to be aware of.

Anne Dwyer said...

Thanks for the comments Froggiemama. She hasn't made a final decision (waiting for Ivies which are a long shot) but she is leaning that way. I think it's a good idea. I guess I'll have to get my passport renewed.

Steve: I totally agree with you on the financial front. We are not a squared away as you are (still have some time on a 15 year mortgage) but we hate debt and won't allow our daughter to borrow for college. We've been preaching to her for a long time about living below her means. I hope it has sunk in.

SteveH said...

I just showed my son the SNL skit with Steve Martin and Amy Poehler called: "Don't Buy Stuff You Cannot Afford."

GoogleMaster said...

I thought of y'all when I read this NY Times column: