MYTH: Saving in a 529 College Savings Plan ruins your child’s ability to qualify financial aid, so you should not save for college.
FACT: Saving in a 529 has a minimal impact on financial aid, but MAJOR impact on your child’s ability to graduate debt-free.
It's true that a 529 College Savings Plan has a small impact on financial aid, but don't fall victim to the myth that you're better off not saving (to maximize financial aid). Today, we will briefly explaining how financial aid works, and then we'll show you concrete examples of the REAL impact of saving for college – on financial aid and your child's student loan burden.
Understanding Financial Aid and Expected Family Contribution (EFC)
Let’s start with a quick introduction to financial aid. In determining a financial aid package, the two most important numbers are your school’s Cost of Attendance (COA) and Expected Family Contribution (EFC). The difference between COA and EFC is your family’s financial need, and this generally determines the financial aid package that you will receive.
Cost of Attendance (COA) - Expected Family Contribution (EFC) = Financial Need
This equation is basically what happens every year, behind-the-scenes, when you fill out the FAFSA, or the Free Application for Federal Student Aid.
Once your financial need is determined, your financial aid package will come from a combination of the federal government, state government, and the specific school. Types of aid include grants (which you do not need to pay back), subsidized loans (which you do have to pay back, with some interest) and unsubsidized loans (which you have to pay back, plus more interest). Since there are so many entities at play, you are not guaranteed that your entire financial need is met; in fact, there is usually substantial unmet financial need.
Wow, lots going on. Things will get clearer if we take a look at an example:
Case Study: To Save or Not To Save?
Why do people think saving for college might hurt financial aid? The logic usually goes something like this:
If I save tens or hundreds of thousands of dollars for college, the government will think I’m rich! And then they won’t help me! I’d better not save at all, so that I get as much free money as possible. I can always take out loans anyway.
Let’s break it down. If you save tens of thousands, will the government think you’re rich?
Let’s consider two extreme examples, both targeting a public, in-state university. Both families make $70K per year, but Jordan’s family saves $0 for college and Abby’s family saves $75,000, which is roughly ⅓ the projected total cost. What happens?
Both Jordan and Abby are going to a public, in-state university. In 18 years, this is projected to cost about $55,000 per year. So, COA = $55,000.
Jordan, our non-saver, has an EFC of approximately $6,000 and financial need of $49,000. He is depending on scholarships and financial aid. He is not guaranteed enough financial aid to cover his full financial need, so let’s assume that financial aid grants generously cover about 50% of financial need, or $24,500. Jordan is left with a bill for $30,500 every year. Jordan’s parents may contribute some of their income and Jordan may pick up a work study job, but likely will also need loans - and by graduation in four years, it could result in $122,000 in student loan debt.
Abby, whose family saved $75,000, has an EFC of approximately $8,000 and financial need of $47,000. Let’s assume she also receives grants covering ~50% of financial need, or $23,500. She receives $1,000 less in grants than Jordan. Abby’s final bill of $31,500 is higher, but she can take $18,750 of that family savings and apply it. The gap to be filled by parent’s income, work study, and loans is only $12,750. In four years, this will be about $51,000.
Yes, Abby “gave up” $1,000 per year in grants… but she graduated with $71,000 less in debt.
How can this be true?
If you’re surprised, you’re not the only one. How can saving $75,000 only increase EFC by $2,000? Well, the EFC calculation is a complex formula that takes into account many different factors like household income, size of household, number of children attending college, and more. Parental assets are a relatively minor factor, assessed at a 5.64% of the asset value or less depending on income (so the maximum that your $75K in savings will increase EFC is $8,067).
You may be thinking: Okay, well, that’s great for Abby’s family - but I can’t save $75,000. With CollegeBacker, your savings can grow over time - so you don’t need to actually put away $75,000 in order to have $75,000 by the time college starts. Click the buttons below to start saving or send a gift today.
Analysis assumes family of four with 1 child in college and older parent aged 45. Assumes $70K HHI, no student income, and no other student or parent assets (primary home and retirement savings are always excluded). Based on rules for 2013-2014 school year.