Financial Aid – Is Saving Penalized?

Ants and Grasshoppers: Are Savers Victimized by the Financial Aid Process?

"My son and his friend attend the same private college, and our families have about the same income. I wondered how his friend’s family could afford that school, since they live in a more expensive house, take nice vacations, and in general seem to spend a lot of money – compared to us, anyway. Since our son was born, we have tried to live below our means and save money for his education. We were shocked to find out that his friend’s family was getting many thousands of dollars more in financial aid. This can’t be fair, can it?"

Everyone remembers the fable of the ant and the grasshopper. The industrious ant worked hard to store food, while the grasshopper lived for the present moment. In the fable, the ant’s strategy proved to be superior, since he had food when it was no longer readily available. In today’s financial aid process, however, industrious savers seem to be penalized when aid is awarded. What’s going on, and is it worth it to save?

The perception that families that have saved money get less financial aid is, of course, based on fact. Savings increase the expected family contribution (EFC). At first glance, this seems unfair – diligence in saving money should be rewarded, not penalized, right?

The fact is that colleges base financial aid on the income and assets at the time you apply for assistance, looking back at most a year. If you were a millionaire three years ago and a pauper now because you blew your money in an around-the-world gambling junket, you are as much a pauper as the one who has been poor forever.

Furthermore, in most cases colleges can’t really judge the choices you make as to how to spend your money – the can only take into account your income and assets. There IS an element of fairness in this, particularly as far as income is concerned. At the same income level, and assuming the same asset base and other chanracteristics, the family contribution toward college costs will be the same, whether the family chooses to live modestly or beyond their means; the family whose budget isn’t already stretched to the breaking point will be able to meet college expenses with much less pain than the spendthrifts.

Assets, though, are a different matter. All other factors being equal, a family that has accumulated no financial assets will receive more aid – regardless of the exact reasons why they failed to anticipate the expense of college. While some families may be in this situation due to devastating medical expenses, lengthy spells of unemployment, or other "good" reasons, others lack assets simply because they spent their income as it was earned. That asset-poor families get more aid may strike diligent savers as unfair, but colleges simply can’t evaluate each family’s spending patterns over the last decade or two and apportion aid on that basis.

Does This Mean We Should’t Save, or Spend What Assets We HAVE Saved?

This discussion won’t cover specific strategies for asset deployment before applying for financial aid, but rather address the basic question of "ant vs. grasshopper" – is it better to not save at all, and hope for the best at financial aid time?

In general, the answer is "no" – it is indeed better to save for anticipated college expenses, even if these assets will be "taxed" by the financial aid process. There are several reasons why this is the case.

First, assets in the parent’s name are just one part of the EFC calculation, and a relatively modest one at that. Parental savings are "available" to pay college expenses at a rate of 6%, which means that a $50,000 nest egg would increase the EFC by just $3,000. While this is substantial, it is not nearly as big an impact as parental income (salaries, business earnings, etc.) Income is calculated at a much higher percentage, and except for low-income, high-asset families, is likely to be the bigger factor in their EFC.

Second, while assets usually take many years to accumulate, a family won’t know about eligibility for financial aid until the college years are quite close – a "no asset" strategy could backfire if, due to a job promotion, family income goes up enough to make financial aid unlikely.

Third, financial aid is often a mixed blessing – at most colleges, a signficant portion of the aid may come in the form of student loans. While sometimes these may have better terms or a lower interest rate than would be available to a typical borrower, they are still loans which must be paid back.

Finally, a family that attempts to minimize liquid assets in the hope of qualifying for more aid is leaving itself vulnerable to many kinds of misfortune unrelated to college: unanticipated job loss, unreimbursed medical expenses, temporary disability, etc. Most financial advisors recommend having at least six months of family income in an easy-to-access, liquid account to handle emergencies of this type. A family without savings is in a precarious situation – while some families may find themselves in this situation because of circumstances beyond their control, it is foolhardy for a family to consciously plan to minimize savings.

Conclusion. In short, despite the financial aid penalty paid by savers, it is still better to be an ant than a grasshopper. Naturally, wise deployment of the accumulated savings can still help minimize a family’s EFC (some asset types aren’t considered in the EFC calculation, for example) – check our other College Confidential financial aid articles for suggestions on how to maximize aid and minimize the burden of college costs.

The Financial Aid Conundrum
     The Dooley Uncertainty Principle of College Costs
     Five Quick Steps to Prepare for College Financially

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