For small business owners, understanding three little words—expected family contribution, or EFC—can save on college costs (we’re talking thousands of dollars). How you structure your business, where you hold assets and which schools your child applies to all affect your EFC.
So, where to begin?
Try these strategies to make your business work to your advantage:
Strategy #1: Save on college costs by holding assets in your business rather than in a personal account. Why? Because under current FAFSA (Free Application for Federal Student AID) rules, assets of businesses with fewer than 100 employees don’t count toward a family’s EFC.
Savings: Personal assets are assessed at a rate of 5.64%, while small business assets don’t figure into the EFC formula at all.
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Strategy #2: Restructure your business in order to reduce your gross income. If you have a sole proprietorship, consider converting to an S Corp. so you can shelter non-retirement assets. Already have an S Corp.? Converting to a C-Corporation, or a “non-pass-through” equity, can also be a good trade off. Yes, you’ll have to pay more taxes on corporate profits, but the potential to save on college costs is often worth it.
Savings: Small business owners can realize potentially huge savings since, under FAFSA rules, adjusted gross income is assessed at a full 47%. And, if you find yourself having trouble covering personal expenses, FAFSA won’t penalize you for taking a loan from your business.
Yes, you’ll have to pay more taxes on corporate profits, but the potential to save on college costs is often worth it.
Strategy #3: Hire your spouse or children. One advantage to this is that it allows you to set up a medical reimbursement plan (IRS Section 105) to pay for your family’s estimated medical costs (up to $5,000 per year). Plus, your child can earn up to $6,300 per year before their income is assessed under FAFSA rules.
Savings: Both tax and FAFSA advantages.
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Strategy #4: Never have savings in a student’s name. One alternative is to have your children save their assets in a personal Roth IRA. These are not counted into the financial aid formula. Plus, as long as your child uses the funds to pay for qualified education expenses, the 10% penalty for withdrawing funds before age 59 ½ is waived.
Savings: A student’s Roth IRA won’t figure into a family’s EFC. Parents’ assets are assessed at 5.64% with an asset protection allowance of around $19,500. Children’s assets are assessed much higher,at 20 to 25%, depending on the school. And, they have no asset protection allowance.
Strategy #5: Tell the grandparents thanks, but no thanks—for now. Maybe grandma and grandpa opened a 529 to save for your child’s education. That money won’t count towards your or your child’s assets on the FAFSA while it’s in savings, but once it’s withdrawn, watch out. It’s better to encourage the grandparents to save any donations for a child’s last year of school, after they’ve filed their last FAFSA, or as a gift when they graduate.
Savings: This could be in the thousands of dollars. To illustrate, say Grandma pays $16,300 for your child’s first year of tuition. That raises the family’s EFC by $5,000. What’s worse, if the student has already reached their income protection allowance (currently at $6,420), their EFC could rise by over $8,000.
It’s better to encourage the grandparents to save any donations for a child’s last year of school, after they’ve filed their last FAFSA, or as a gift when they graduate.
Strategy #6: Leave retirement savings alone.
Savings: Yes the government does waive the 10% penalty on funds withdrawn to pay for college, but those funds also serve to increase a parent’s income, which is assessed at 47% under FAFSA rules.
Strategy #7: Talk to your tax adviser about how to effectively withdraw from your 529. Doing so will make sure you don’t miss out on the American Opportunity Tax credit. Paying a student’s entire college costs out of a 529, therefore reaping the benefit of the tax-free distribution, disqualifies parents from also taking the American Opportunity Tax credit because the government considers this “double-dipping.”
Savings: The credit can save on college costs up to $2,500 in the form of “free money” from the government.
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Strategy #8: Educate yourself about EFC reduction strategies. The book Paying for College Without Going Broke by Kalman Chany is a great place to start. A CPA can provide further assistance. But, to make sure you have the most current, complete information available, consult an experienced college planning specialist.
Savings: The potential to save on college costs comes from all the tips listed here, plus more that fit your personal situation.
Strategy #9: Learn the different methodologies for EFC reduction strategies. Not all schools calculate this in the same way. For example, some schools do not use the equity in one’s home to calculate EFC, but others do.
Savings: With a school that doesn’t use home equity to pay down one’s mortgage, cashing in $150,000 in stocks to pay down a home mortgage could save $7,500 a year in college costs. But at schools that use Institutional Methodology, which assesses home equity, this not only wipes out that potential $7,500 savings but costs in potential future earnings by liquidating the stocks.
With a school that doesn’t use home equity to pay down one’s mortgage, cashing in $150,000 in stocks to pay down a home mortgage could save $7,500 a year in college costs.
Strategy #10: Remember that financial aid awards can be appealed. A change in family income and unexpected medical expenses are both valid reasons to appeal awards. It also can be worth appealing if one or more schools that are similar to your child’s first-choice school offer a higher award. In this case, if you go back to that first-choice school, they’ll sometimes sweeten their offer. For best results, read up on how to write a good appeals letter before you act, or seek out the advice of a local college coach who does this kind of work.
Savings: When your child is able to attend their first-choice school at a price you can afford—priceless.
Jim Slowik strategizes for families of all incomes to leave no stone unturned to reduce college costs. Jim has worked for over 30 years in marketing and management with 20 of those years in financially related industries. As a parent of college students, Jim understands the challenges of navigating the college process. He holds a…
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