How to get your kids through college without going broke

You may be vaguely aware that the cost of college keeps rising faster than inflation, but that doesn’t necessarily mean you’re ready for the sticker shock when your kids start applying for schools. Currently, the average cost of a year of undergraduate education is $38,270 per student per year, which includes the cost of books, supplies, and living expenses.

Unfortunately, college tuition costs go up every year by about 4.1%. That means a student starting their education with a price tag north of $38,000 in 2024 is likely to be paying nearly $45,000 for their final year of schooling in 2028.

But just because college costs are unreasonable doesn’t mean your kids’ only option is to live off-grid in a yurt. There is plenty that you and your nearly adult children can do to protect your finances and afford an education. Here’s what you need to know.

Understanding the FAFSA Student Aid Index

Completing the Federal Application for Free Student Aid (FAFSA) may feel dauting, but it’s an important part of paying for college. The responses you and your student provide on the FAFSA will help determine how much federal aid your student qualifies for, as well as what financial aid the school will offer your child.

From the 2024-2025 school year onward, your student’s federal need-based aid eligibility is determined by the following equation:

Cost of attendance (COA) – Student Aid Index (SAI) = Financial Need

For instance, if your COA is $25,000 and your SAI is 5000, then your financial need is $20,000. That means you will not be eligible for more than $20,000 in need-based financial aid.

The student aid index replaces the expected family contribution (EFC), although both metrics are calculated based on the student’s and parents’ income, assets, taxes, and demographic information. You can use this calculator to estimate your child’s SAI.

Assets included in the FAFSA

When filling out the FAFSA, you’re required to include the following financial information about yourself and your dependent student:

• Federal income tax returns
• Child support records
• Current checking and savings account balances
• Money in taxable investment accounts, brokerage accounts, money market accounts, and trust funds
• Real estate investments
• Money in a 529 education savings account owned by a dependent student or their parents

In other words, the federal government asks you to include these specific assets to calculate your student’s SAI. The larger the assets on this list, the less need-based financial aid your student can qualify for.

Including the 529 plan

While the money in a 529 plan account is included in the SAI calculation, that doesn’t mean you’ve shot yourself in the foot by setting money aside in the account. While the value of the parent or dependent-owned 529 account is counted as an asset on the FAFSA, the money in your 529 account will only lower your student’s financial aid package by a maximum of 5.64% of the account value.

For example, let’s say you have $15,000 set aside in your child’s 529 account. Your child’s aid award could be reduced by up to 5.64% of $15,000, or $846.

However, neither earnings in the 529 account nor withdrawals from the account for education expenses are included on the FAFSA. This means that any 529 account growth or withdrawals for qualified expenses will have no effect on your child’s financial aid. This can often make up for the loss of 5.64% in the financial aid package.

But that’s not the only good news about your 529 plan. You can also potentially exclude it from the FAFSA entirely if you choose the right owner.

How to exclude a 529 plan

If someone other than the parent of the dependent child owns a 529 plan, the value of the plan has no effect on the student’s financial aid package. In other words, if your child’s grandparents, aunt and uncle, or other extended family owns a 529 plan for which your child is the beneficiary, FAFSA does not require that you include the 529 plan assets in its calculations.

In the past, grandparent-owned (or other non-parent-owned) 529 account assets were similarly excluded from FAFSA calculations, but any distributions from these accounts would be considered untaxed income for the student using the money. This untaxed income would affect the student’s financial aid.

But starting with the 2024-2025 school year, a grandparent-owned 529 account will have zero effect on your child’s financial aid eligibility. Any distributions from a grandparent-owned (or other non-parent-owned) 529 account is treated the same as distributions from a parent-owned 529 account. It is not included as part of the student’s income.

If you already have a 529 account that names you or your dependent child as the owner, you can transfer ownership to your child’s grandparents or another relative. The specific requirements will vary depending on the state you live in and which brokerage holds your 529 account plan. Check with your 529 plan to determine what you need to do to transfer ownership.

Assets excluded from the FAFSA

In addition to grandparent-owned 529 accounts, FAFSA excludes several other specific assets in its calculation. Here are the excluded assets you are most likely to own:

• Qualified retirement plan accounts, such as 401(k) plans, IRAs, and Roth 401(k) or IRA plans
• Pre-tax contributions to qualified retirement plan accounts
• Your primary residence
• ABLE accounts (for disability related expenses)
• The value of life insurance

Money you set aside in these assets do not factor into your student’s financial aid calculation. This means you can improve both your child’s and your own financial situation by maximizing these assets–at the right time.

Your base year assets

The FAFSA uses your income and taxes during your student’s base year–the calendar year that runs from January 1 of your student’s sophomore year in high school to December 31 of their junior year–as the starting point to calculate your student’s SAI. This base year may also be referred to as the “prior-prior year.” For example, students who are starting college in the fall of 2024 have a base year of 2022.

Smart asset management during the base year

All together, these FAFSA rules about timing and asset inclusion make it clear that maximizing your retirement contributions during your child’s base year is the best use of your money. Neither the pre-tax income you set aside in your 401(k) or traditional IRA nor the value of these accounts will be included on the FAFSA.

By maximizing your contributions, you get to build your retirement nest egg, lower your taxable and FAFSA-reportable income, and increase your child’s chances for receiving need-based financial aid. The more money you can afford to put into your retirement account during this all-important year, the better off you, your nest egg, and your child will be.

Launching your kids without destroying your finances

The continually rising cost of higher education may be a slow motion disaster, but that doesn’t mean you need to let it derail you. Once you understand how colleges calculate financial aid, you can take the steps necessary to protect your own and your child’s future.

Transferring ownership of your child’s 529 plan to a grandparent or other trusted family member (while keeping your kid as the named beneficiary) can give your student a small boost in qualifying for need-based financial assistance. But prioritizing your retirement contributions during your kid’s high school years will give you an even bigger benefit. This will not only reduce your taxable income and the assets included on the FAFSA, but also help ensure your secure retirement.