Financial Aid

Financial Aid: Minimizing the Parent Contribution

As a parent of a current college student and five more in the near future, I’ve been trying to understand the student aid calculations. Last time, I wrote about how much the parents are expected to pay for their child’s education. The focus of this post is to see what it would take to drive the expected parent contribution to zero.

The first place we’ll start is income.

Income Protection Allowance

The Expected Parental Contribution (EPC) calculation understands that not every penny of parental income can go towards funding Junior’s education. After all, even parents need something to live on as well as feeding, clothing and sheltering other children. The Free Application for Federal Student Aid (FAFSA) calls this an “income protection allowance.” If you make less than this allowance, then you’re not expected to provide any financial aid for your child’s education. The amount is adjusted for the household size and the number of college students in the household.

For example, a single parent with one student has an income protection allowance of $19,440. My family of six kids with one student has an income protection allowance of $50,570. If my adjusted gross income is below that amount, none of my income is expected to cover my child’s education expenses.

Tax Allowances

The EPC calculation excludes taxes paid, including net federal income tax paid, a state and local tax allowance, and social security taxes. It wouldn’t be very fair to expect money spent on taxes to also be considered available for paying education expenses.

The social security tax is likely the easiest tax to reverse out of available income. Divide $50,570 by (1-7.65%) to discover that our income can be $4,189 higher, or $54,759 for a zero EFC.

Reversing state and local taxes is more complicated. Tax burdens vary by state. You’ll need to know your home state’s percentage from the FAFSA tables. The percentage can be as high as 10% (New York) or as low as 1% (~15 different states). My home state of Virginia has a 4% allowance for incomes over $15k. Dividing $54,759 by (1 – 4%) gives me an additional $2,282, or $57,041.

Lastly, we reverse net federal taxes paid. With a married filing jointly (MFJ) filing status, my standard deduction was $24,400, leaving me with $33,446 of taxable income or $3,635 in tax. However, that’s the gross I would have paid, not my net tax. In 2019, my oldest no longer qualified for the child tax credit but my other children did, bringing my total tax credits to $10,500 (5 children * $2,000, 1 dependent child * $500). I would have paid no federal tax, so there’s nothing to adjust.

But we’re not done. The taxes aren’t independent. Each bump in income to account for a tax means that I pay more in the other taxes, which need to be recalculated again. In reality, the equation looks something like $$X – X*7.65\text{% (FICA taxes)} – X * 4\text{% (state tax allowance)} = $50,570$$ That simplifies to $$X = $50,570 / (1 – 7.65\text{%} – 4\text{%})$$ or $57,238. which is how much we can earn as parents before the EPC rises above $0

Here’s a graph that shows the relationship between income and the EPC:

Once the EPC moves from $0, every dollar earned is expected to contribute somewhere between $.19 and $.42 to education expenses. The funny bumps in the EPC % line (green) are because of the interaction between FICA limits, progressive federal tax brackets, and a progressive EPC calculation.

Assets

The other component in the EPC calculation are assets. Assets include bank accounts, taxable brokerage accounts, rental properties, and businesses you own (with some limits). It includes 529 accounts that you or your student own, regardless of who is the beneficiary. 

Assets exclude some biggies, such as tax advantaged retirement accounts (e.g. IRA, 401(k), etc.) and your primary home or the family farm that you live on and operate. Prioritizing your retirement accounts and paying off your mortgage can lower your EPC.

Like income, assets have an allowance. The allowance varies according to the oldest parent’s age. For example, if the oldest parent was 45 years-old, the first $6,200 of assets would be excluded from the EPC.

After summing up your assets and subtracting the asset allowance, you multiply the total by 12%. That’s how much assets contribute to the EPC.

Interestingly, if your earned income was zero, you could have assets of $427k and still have a $0 EPC. The following graph shows how assets can use incomes below the $57,238 floor.

Assume a household income of $57,238 and an EPC of $0. How do assets affect the EPC?

Assets have a much smaller impact on our EPC than earned income. At worst, 5.64% of every asset dollar will be expected to go towards education, compared to 32.7% of every earned dollar.

The following chart shows how EPC increases as assets grow:

Conclusion

When it comes to paying for college, savings have a significant advantage over earned money. Depending on your household size, you can earn quite a bit before you’re expected to pay anything towards your child’s education. If you engineered this right, you could end up with an EPC of $0 as your child heads off to school.

I’d love to hear your thoughts. Drop me a comment.

Hasta luego!

2 thoughts on “Financial Aid: Minimizing the Parent Contribution

  1. Thanks for the post. Based on what you wrote, we’re sort of hosed given our income, asset base, what’s in the 529 plan and having only one kid going to college. I need to run the numbers if I retire before my kid goes to college. Maybe the low income resulting will give us some benefit. My conclusion is that the prepared are punished.

    1. Thanks for the comment. Indeed, the prepared are punished. If your income is low enough to qualify for Medicaid, there’s a simplified FAFSA that excludes parental assets altogether. I guess they figure that if you’re on Medicaid, why bother making you report assets when they almost surely don’t exist.

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