The cost of education can surprise even experienced advisers who are already well aware of the cost of life’s big purchases.

The College Board puts the average cost of tuition, fees, room and board at private nonprofit four-year institutions at $45,370 for the 2016-2017 school year. Bear in mind, though, that’s the average, so the cost of sending a child to certain colleges can be north of $60,000 a year — enough after-tax dollars to make even high-income clients feel the pinch.

Davidson College (Bloomberg News)
Davidson College (Bloomberg News)

Now for the good (well, not so daunting) news: The average net cost at private colleges and universities is almost $20,000 less, at $26,100. That net price is after grant aid and tax benefits, so advisers can add great value by showing clients with teenagers and preteens how to save tens of thousands of after-tax dollars a year.

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Advisers can add great value by showing clients with teenagers and preteens how to save tens of thousands of after-tax dollars a year.

FILE AS EARLY AS OCTOBER

A vital step to obtaining financial help for college is filling out the Free Application for Federal Student Aid, so knowing the new FAFSA rules is crucial for advisers. “The start date for the FAFSA has moved up by three months, from Jan. 1 to the previous Oct. 1,” says Mark Kantrowitz, publisher and vice president of strategy at Cappex.com, a website about college admissions and financial aid. Thus, the FAFSA for the 2018-2019 school year can be filed as early as Oct. 1, 2017.

And filing as early as possible is important. “It makes sense to begin filing in October because some colleges offer aid on a first-come-first-served basis,” says Deborah Fox, CEO and founder of Fox Financial Planning Network and Fox College Funding, both in San Diego. “In addition, some colleges require the student to file a FAFSA to be considered for merit aid, even if the family will not qualify for any need-based aid.”

Moreover, as Kantrowitz points out, “instead of using tax returns for the previous year, the FAFSA is now based on the year before that.” On the FAFSA, applicants now use “prior-prior-year” information from tax returns that already have been filed — for example, the 2016 tax return for the 2018-19 school year. Early filers no longer will be able to estimate income on the FAFSA and then supply numbers from a tax return that is filed later.

What does this mean for advisers? “The new financial aid filing protocol requires parents to plan much earlier for funding college,” says Beth Walker, partner at the Wealth Consulting Group, a wealth management firm in Las Vegas. “Ideally, parents would optimize their income tax reporting beginning in their child’s sophomore year of high school so as to create the best possible base line for financial aid. The tax year straddled by a student’s sophomore and junior year of high school will now set the table for the family’s aid eligibility for college.”

Kal Chany, founder and president of Campus Consultants in New York, which provides college financial aid planning, agrees that planning for college now should start when clients’ children are in the ninth or 10th grade. “It probably won’t be difficult for advisers to convince clients to begin that early,” he says. “At that stage, paying for college is on their mind; it’s one of their biggest concerns. We’ve done presentations to middle school groups and attracted very large turnouts.”

INCOME’S IMPACT

“The key takeaway is that advisers and tax preparers need to be aware of what years a client’s child or children will be in college,” says Marty James, a CPA who heads an investment and tax management firm in Mooresville, Indiana. Planning can focus on preparing a FAFSA that might qualify for financial aid, in the fourth quarter of the year before the student will start college.

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“The new financial aid filing protocol requires parents to plan much earlier for funding college. Ideally, parents would optimize their income tax reporting beginning in their child’s sophomore year of high school.”

“The new rules should help considerably in filing the FAFSA with certainty, rather than using estimates,” says Joe Hurley, a CPA who is the founder of the Savingforcollege.com website. “Planning tactics for the base year — deferring income, for example — won’t really change. It’s just a different base year than what we were used to.”

As Hurley’s comments indicate, one prime goal of FAFSA planning is the reduction of reported income. Up to 47% of parents’ income and 50% of a student’s income (after certain allowances) are expected to be used for college, thus reducing potential aid. Deferring income, according to Hurley, might include delaying certain actions, such as converting to a Roth IRA, until after the years for filing FAFSAs are past. Advisers also might suggest accelerating such actions to years before they’ll show up on a FAFSA.

“Now that the prior-prior-year tax return numbers are used to determine if a family will qualify for need-based aid, earlier planning is required to drive the student’s and parents’ adjusted gross income down as much as possible on those tax returns,” Fox says.

Kantrowitz reports that parents who plan ahead may take retirement plan distributions or realize capital gains before the base year. “With the switch to prior-prior year tax returns,” he asserts, “parents need to take these actions before January 1 of the sophomore year in high school.”

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One prime goal of FAFSA planning is the reduction of reported income. Up to 47% of parents’ income and 50% of a student’s income are expected to be used for college, thus reducing potential aid.

Advisers may have more ability to help in this area if clients are business owners. “For income purposes, many small businesses are S corporations,” James says. “However, for FAFSA purposes, sometimes using a C corporation may make more sense.” An S corporation passes through all income to the owner or owners, but that’s not true with a regular C corporation.

DELAY CASH FLOW?

Just as advisers might suggest accelerating income to pre-FAFSA years, there are times when it’s better to delay cash flow. “On the back end,” Kantrowitz says, “the new schedule also moves up the date after which income no longer affects aid eligibility, assuming that the student will not immediately be going on to graduate school.” Grandparent-owned 529 plans may provide such an opportunity to win by waiting.

If a 529 plan is owned by the student’s grandparent, the account balance is not reported as assets on the FAFSA. “However, distributions from a grandparent-owned 529 plan are counted as untaxed income to the student on a subsequent year’s FAFSA, reducing aid eligibility by as much as half of the distribution amount,” Kantrowitz says.

“Now,” Chany says, “families will be able to use a grandparent-owned 529 plan sooner. Distributions can begin Jan. 1 of the student’s sophomore year.” Advisers can point out that tax-free distributions from a grandparent’s 529 may be able to start then without having a negative impact on student aid.

MAKE A FAFSA MORE AID-WORTHY

In addition to income management, advisers might be able to make a FAFSA more aid-worthy by reducing reported assets. “With regard to assets, the FAFSA is a snapshot, on the day the form is filed,” James says. “To reduce a family’s expected cost for college, advisers might recommend that clients fund their Roth IRA or a nondeductible traditional IRA before filing the FAFSA. Otherwise, clients might wait until the following year to make the previous year’s contribution.”

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Again, business owners, professionals and farmers may have some advantages. James cites the FAFSA’s small business exclusion as an income- and asset-reduction opportunity: small businesses that are owned and controlled by the family are excluded as assets on the FAFSA.

“One example,” James relates, “involved a client who was farmer, operating as a sole proprietor. We took the farm operation, changed the tax entity to a C corporation with a fiscal year-end, and limited the salary income that would show up on the personal tax return. Almost all of college was paid for without family contributions. Farm income fluctuates from year to year, so we could use operating losses in certain years to get back the taxes paid in higher years.”

‘THEY FAIL TO CALCUATE

The accelerated FAFSA schedule has advantages and drawbacks for advisers as well as clients. On the positive side, “these FAFSA changes should provide an additional window between the time financial aid award letters are received by students and the moment a deposit is required by the college,” says Jerry Inglet, director of M&T Securities’ College Financial Literacy Initiative. “This provides a slight increase in the time to plan, review, compare and examine financial aid award letters.”

Some award letters have terms that may not be understood. “For example,” Inglet says, “many parents do not know the difference between a subsidized or unsubsidized federal student loan. They fail to calculate the gap between what has been awarded and the net cost of attending the college.” With more time for review, an adviser could explain the terms and help families “select a college that is not only a good academic and social fit, but also an appropriate financial fit for the student and parents,” he adds.

Nevertheless, the prior-prior-year tax return requirement might present difficulties. “Because there is more time between the base year and the FAFSA filing, the risk of a significant change will increase,” Hurley says. “The Department of Education encourages financial aid administrators to use ‘professional judgment’ in making adjustments when circumstances have changed for the student and/or parents.”

Planners with clients in such a situation can encourage an appeal. “If the lower income is permanent (say, because of a job change or salary reduction or death of a wage-earner), most colleges will substitute an estimate of income,” Kantrowitz says. “If the income varies from year to year, perhaps for a self-employed person, colleges will typically substitute an average of income during the last three to five years.”

Advising clients about college aid may require some self-education. But if planners can help clients in this area, the payoff will be immediate, perhaps substantial and extremely visible. Thus, financial aid planning can be an effective way for advisers to demonstrate the value they’re providing to clients in the near term. “I have found that to be the case,” James says. “Although I am not an expert in financial aid, I know enough to see some opportunities when they are in front of me.”

Donald Jay Korn

Donald Jay Korn

Donald Jay Korn is a contributing writer for Financial Planning in New York. He also writes regularly for On Wall Street.