How to play the college financial-aid game

Many parents who plan to send – or help send – their children to college are likely to be concerned about those ever-rising tuition bills that lie ahead.

To meet the expense, mom and dad can put money each year into 529 plans or other education-related accounts.

But there's another side to the paying-for-college equation: financial aid.

Financial advisers say parents need to think seriously about the subject when their child becomes a sophomore in high school. At that point, parents can take a number of perfectly legal steps to ensure that they maximize their eligibility.

"Families should do whatever they can do to place themselves in a position to receive financial help they need for their kids to go to school," says Betsy Porter, director of admissions and financial aid at the University of Pittsburgh.

The key is thinking ahead. While financial-aid applications are submitted in January of a student's senior year in high school, aid eligibility is based on the previous tax year.

So financial-aid officers will look at a 2002 tax return for a current junior entering college in the fall of 2003. "It's critical for sophomore parents to do a complete tax review," says Judy Miller, a certified financial planner in Alameda, Calif.

To maximize eligibility, parents need to consider both their own assets and income as well as those of their college-bound child. Here are some tips offered by financial planners in each of these four areas:

Parents' assets: While 35 percent of student assets are counted as part of the family contribution, less than 6 percent of parental assets are counted in the contribution. In other words, 35 cents of every dollar in savings a child accumulates is knocked off the eligibility. So it's better to have assets in a parent's name than the child's name.

In addition, parents should use their savings to reduce consumer debts and loans, or shift the money into assets not included in the aid calculation, says Dean Knepper, a certified financial planner in Leesburg, Va. Pay off credit-card debts, car loans, and life-insurance policies, since the net-cash value of such policies is excluded from the aid formula, Mr. Knepper says.

If parents have investments that are not needed to pay for college, they can be put into an annuity prior to submitting the aid form. Annuities owned by a parent are also not included in the financial-aid calculation.

Another tip: Avoid transferring investments into custodial accounts for the student. "Investments transferred into a custodial account are irrevocable gifts and can't legally be transferred back to the parent," Knepper says. "It doesn't matter if the money is to be used later for the child's benefit."

Parents' income: Try to accelerate any income, including bonuses or gains on investments, into the prior year while deferring losses to the next tax year. Avoid selling stocks that generate large capital gains in the tax years when aid is calculated. Taking such a step increases income during that year, reducing aid eligibility.

Double up on retirement contributions in the years prior to college. While the student is in college, parents' retirement contributions are added back to calculate total income, but anything contributed prior to college entrance is not counted as an asset for financial-aid purposes, Ms. Miller says.

She emphasizes that it's vital not to skimp on total retirement contributions. "You can make very poor emotionally based decisions when you're looking at the college decision and many years later find you can't achieve retirement."

Children's assets: Investments in the student's name should be used to pay for the student's expenses prior to submitting the aid form. Items purchased – computers, cars, clothing – are not included as reportable assets under the financial-aid formulas.

Children's income: Miller advises against having children work during the junior year of high school, since as much as 85 percent of every dollar earned will be deducted from aid eligibility. "The most important job is focusing on academics," Miller says. "Junior-year performance is what admissions officers are looking at."

Relatives other than a parent who want to contribute to college savings should consider setting up a 529 plan with themselves as account owner, and naming the student as beneficiary.

That way, Knepper says, the value of the account is not included as an asset in calculating financial aid.

If possible, Knepper advises deferring taking distributions from any savings plan until January of the student's junior year of college. That way, the earnings are not included as income on the financial-aid form, which is submitted annually.

Parents must be careful not to cross the line from maximizing their eligibility to hiding their income or assets, financial-aid officers warn. For instance, if a tax return shows dividend income for a child, but the asset is missing on the financial-aid form, that suggests to the officer that you're trying to hide assets.

Also, avoid precipitous, hard-to-explain dips in income during a single year.

"It's a question of playing within the rules," says David DeBlois, director of the College Planning Center of Rhode Island. "It's not something [where] you can posture and beat the system."