Strategies for optimizing college financial aid, and six factors to warn your clients about.
By Sandy Voit, MS, EdS, LMHC, CDFA
Many divorce settlements don’t effectively take the impact of college financial aid into account – you can preserve equitable Head of Household status and Child Tax Credits while still maximizing their student’s financial aid.
When couples are getting divorced and there are children who either are already enrolled, or have yet to enroll, in college, there are some factors that should be taken into consideration when structuring their settlement.
Strategies for Optimizing Financial Aid
First, if your client already has a child in college, have the parent contact their child’s financial aid office immediately to inform them that a divorce is in process. Most colleges provide additional financial aid, even prior to finalized divorce, and will tell you what information/documents must be provided.
When a divorcing couple’s child applies for aid, whichever parent is considered the custodial parent – i.e., the parent at whose residence the child stays one night/year more than the other, or if the same, whoever is providing more than 50% of the student’s support – would be the parent whose tax return information is required.
For parents whose incomes are significantly disparate, their child may wind up with more financial aid if the lower taxable income parent was the custodial parent as it would be that parent’s income that drives the financial aid eligibility process. Their child might receive scholarships, or even subsidized federal loans that significantly reduce that child’s future debt!
For example, a child who receives a Stafford loan pays 4.45% interest (for 2017-18) and no interest at all as long as they are at least a half-time student plus six months after they leave school.
Undergraduate students can borrow subsidized loans up to $19,000 ($3500 freshman year; $4500 sophomore year; and $5500 as juniors/seniors). The interest savings are significant! (If they were to receive the maximum $19,000 in subsidized loans, the savings would be about $2500 while they were enrolled plus six months.)
In return for one parent “giving up” their share (two year’s worth, assuming a child is in college for four years) of the years in which they could have had the child tax credit (under the Tax Reform Act of 2017, there are no more dependent exemptions), that parent would be able to then claim that same child for two additional years after the senior-year FAFSA was completed. So, rather than structuring a support settlement whereby each parent alternates who is the custodial parent, structure it to maximize financial aid.
Grandparents who have set up 529 plans for grandchildren should hold off on using them until after their grandchild has submitted their FAFSA in their sophomore year of college. Otherwise those payments are considered the student’s income, who would lose 50% of those payments in financial aid.
When there will be more than one child in college at the same time, have the lower income parent be the custodial parent for both. The Expected Family Contribution states the amount that the Family is expected to pay towards their child/ren’s education. When there is more than one child enrolled in college, the EFC is divided among the students. If the family’s EFC is $10,000 –the family has to pay the first $10,000 of a child’s costs before any financial aid is considered – when two children are in college, each would have $5000 of the EFC – so each would get an additional $5000 in aid.
Some Factors to Warn Your Clients
- If custodial parent remarries, the combined household income is used in the FAFSA process (regardless of whatever the divorce decree states).
- The non-custodial parent should “own” the 529 plan as it would otherwise count as an asset of the custodial parent and lower aid.
- The value of a vacation home is counted as an asset.
- Inheritance to child or custodial parent would be counted as asset.
- Sale of family home, if not rolled into another family residence, counts as an asset. (As would taking out a HELOC for college and putting it in the bank.)
- Retirement (cliff vesting, buy/sell agreement) would yield more assets.
You might suggest that your clients consult with their financial planner or the financial aid director of a college prior to their child’s sophomore year in high school for optimal planning, due to the Prior/Prior Year tax return impacting financial aid – and students generally receive their best offers for their first year at college.
Sandy Voit, a Certified Divorce Financial Analyst, and Licensed Mental Health Counselor, has worked on 430 Divorces. Sandy is a former Director of Financial Aid, and former board member of the Association of Divorce Financial Planners. Sandy Practices in Kirkland, WA.