Financial Aid Myths
Don’t be misled; saving for college is still the best strategy.
By David Yeske, CFP

As college costs skyrocket — it’ll cost nearly $38,000 to attend Harvard in 2003–2004 — the lure of financial aid grows stronger. While financial aid is necessary for many families, strategies to maximize it often are based on myths. 

Myth No. 1: Saving money hurts financial aid. It’s true the more money you save for college, the less you’re likely to receive in financial aid — but that’s good. According to the College Board, in the 2002–2003 academic year, the federal government, colleges, and states distributed $90 billion in financial aid — three times the total 10 years ago. But only 39 percent of that was in the form of grants (which you don’t have to pay back), and most of those went to lower-income families. The majority of financial aid, particularly for middle-income students going to public colleges, comes in the form of low-interest loans, augmented by some work-study aid.

If you know you’ll end up borrowing for college, it makes more sense to save as much money up front as possible (without sacrificing retirement savings). It’s smarter to save money and earn a return (especially when you can start well in advance) than to borrow money and pay interest on it.

Myth No. 2: Don’t choose an investment vehicle solely because it increases financial aid. The vehicle you use to save and invest for college affects financial aid because student assets count significantly more heavily against financial aid than parents’ assets do. Aid formulas treat assets saved in a 529 savings plan or taxable mutual fund as parental assets, while assets in Coverdell educations savings accounts, custodial accounts, and 529 prepaid tuition plans are considered a student’s assets. Investment vehicles should be chosen based on multiple reasons, such as investment and tax benefits, not just financial aid. 

Myth No. 3: Ability to pay is not a factor in admissions. Colleges may not admit it, but a student’s ability to pay for most college expenses is becoming a factor in determining admissions at some schools, according to a March 2003 article in the Journal of Financial Planning. This is because college endowment portfolios have been hard hit by the bear market, and state schools have suffered cutbacks due to state budget crises. Schools have less aid money, particularly grants, to distribute. Thus, the more you can pay yourself, the greater the number of school choices your child has, all else being equal.

Myth No. 4: The wealthy need not bother to apply for aid. Even some higher-income families may qualify for need-based financial aid due to circumstances such as multiple children in college. More important, there has been a rise in merit-based aid, which is available to any qualified student regardless of financial circumstances.

Myth No. 5: It’s smart to shift assets. When calculating federal financial aid, the government counts up to 5.6 percent of parental assets. But some assets are not included in that assessment, such as retirement accounts, annuities, life insurance, and home equity. Consequently, some families try to divert money into these assets. This provides only marginal benefit from an aid standpoint, and in the process you may put money into something you don’t need, such as annuities or extra life insurance.

Income weighs far more heavily in aid calculations than assets. The federal aid formula requires from 22 percent to 47 percent of your available income (a figure smaller than your adjusted gross income) be devoted toward tuition. Hence, strategies like delaying income into the following year can help. (Don’t ask your boss to reduce your paycheck, however; it’s not worth it.)

When all is said and done, financial aid is important, but you shouldn’t let the quest for it derail the single best strategy for paying for college — saving money!