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Financial Aid: A Primer

By Harold Simansky
Educational Investment Advisor

If you’re considering financial aid to help pay for your offspring’s education, you won’t be alone. According to the Department of Education, 63 percent of all undergraduates enrolled in 2003–04 received some type of financial aid, and this number keeps going up. In this article, we cover some of the basics of how financial aid works.

First, let's define it. Financial aid is any type of assistance used to pay college costs that is based on financial need. It generally comes in one of these three forms:

  • Grants and Scholarships

    Also called gift aid, grants don't have to be repaid and you don't need to work to earn them. Grant aid comes from federal and state governments and from individual colleges.
  • Loans

    Most financial aid comes in the forms of loans — aid that must be repaid. Loans are common, making up nearly 54 percent of all financial aid. Most need-based loans are low-interest and sponsored and subsidized by the federal government, which means no interest accrues until after graduation.
  • Work-Study

    Student employment and Work-Study aid help students pay for education costs such as books, supplies and personal expenses. Work-Study is a federal program that provides students with part-time employment.

The Family's Contribution

The big question, of course, is how much of this aid you can depend on. One of the basic premises of college financial assistance is that families of students must take responsibility for as much of the cost as they can. This is referred to as the Expected Family Contribution (EFC), and it can be thought of as the out-of-pocket money you and your child must pay for school. Financial aid can help bridge the gap if your EFC cannot cover all the costs.

The federal government and most universities compute the EFC through a formula keyed to both the student's and the parents' available income and assets. (Available income generally means total income minus a number of different allowances.) In calculating financial aid, the formula stipulates that the following percentages of income and assets be used for college expenses in any single year:

  • 35 percent of a student's assets
  • 50 percent of a student's income
  • 2.6 to 5.6 percent of a parent's assets
  • 22 to 47 percent of a parent's income

The percentage contributions for parents vary depending on their economic status and age. Lower-income families and older parents are expected to pay less; higher-income families with younger parents are expected to pay more.

Even at this simplest level, the formula reveals a very important point: To maximize financial aid, it is far better for any savings to be in the parent's name than in the student's name.

A Rough Cut

To get a sense of how much financial aid you’re likely to receive, take 20 percent of your top-line income (before any deductions) and add 5 percent of your assets (but don’t include your residence). This sum provides a rough idea of how much you will be expected to spend for each year of college.

As an example, if you make $100,000 a year and have $200,000 in assets, a university will expect you to spend $30,000. If your child goes to a school with a price tag of $40,000 a year, you will still be expected to pay $30,000 but financial aid will provide the other $10,000. On the flipside, you will get no financial aid if your child goes to a school that costs just $20,000 a year. The way colleges see it, if you’re capable of contributing up to $30,000 for tuition, you can handle the whole burden without their help.

  • Get an estimate of your Expected Family Contribution, using our EFC Calculator.

Making Every Penny Count

A discussion of financial aid invariably leads to the question: "Won't saving for college just hurt my chances of receiving financial aid?" The short answer is yes, but only by a very, very small amount.

Let's take a closer look at the numbers, because the right kind of planning can really pay off. As a parent, you can see from the formula that your assets are "taxed" at only 5.6 percent a year. This means that only about 20 percent of your assets in total are judged accessible for paying for college over the course of four years of school.

That's not all. Under current rules, a large portion of a parent's assets is deemed "protected" from being used to pay for college. The amount protected is based on the age of the older parent, with the benefit increasing with age. Here's an example of how that works. If a two-parent family has $100,000 in assets and the older parent is 55, $50,300 of the assets will be protected. This means $40,700 will be "taxed" at 5.6 percent, for a total contribution to the cost of school of only about $2,800, or less than 3 percent.

As all of this goes to show, the notion that a dollar saved for college equals a dollar lost in financial aid is far from correct. But in any case, the issue of financial aid should not stop you from saving. What you gain in overall financial health more than makes up for diminished college aid.

What we have tried to do here is provide some basic information about how financial aid works. Needless to say, there is other important information we are unable to include. If you still have questions, there are numerous resources available out there to help you understand these issues better.

Article #2 -
Costs, Financial Aid, and Saving


About the Author

Harold Simansky is the founder of Educational Investments, LLC, (www.educationalinvestments.com) a Registered Investment Advisory firm focused on helping families save for education. His book, College Costs How Much?! The Workbook to Help You Save for School, which explains the financial aid process, is available at www.CollegeCostsHowMuch.com. You can send him an e-mail at Harold@edinv.com.




Related Resources

Make sense of all the terms that you have heard during your scholarship, financial aid, and college searches. Also, calculate your Expected Family Contribution (EFC) and compare financial aid awards: