Types of Assets
There are two types of assets to be considered on the financial aid application:
- assessable assets; and,
- non-assessable assets.
The following is a list of non-assessable assets and are not reported on the FAFSA application form.
- Life insurance
- Retirement accounts
- Unexpended financial aid
- Personal items
- Restricted bank accounts
- Personal residence (IM will assess)
- Second or vacation residences are assessed
- Family farms (IM will assess)
- Family farm corporations, partnerships, etc., are not assessed
- Investment farms are assessed
- Siblings’ assets (IM will assess)
- Businesses with less than 100 employees (IM will assess)
Annuities (including both qualified and nonqualified annuities) are non-assessable assets.
Caution: Some private colleges do assess annuities when computing the EFC. The financial advisor should contact each college that the student is interested in attending and inquire about its policy regarding assessment of annuities.
Since annuities are generally not assessed in the EFC calculations, it may be advantageous to convert assessable assets, such as CDs or cash, to non-assessable annuities before the financial aid application is signed. Another advantage of an annuity as a college savings investment is the tax-deferral of earnings.
Caution: Variable annuities, a mutual fund-type annuity, are attractive to some families as a way to save for college. The advantages of this type of investment are their tax-deferral of earnings and ability to keep up with the high inflation rates of college. However, there are some disadvantages to these types of investments.
The possible disadvantages are:
- high selling and administration charges
- lack of liquidity
- lack of loan features
- the conversion of low-taxed capital gains into high-taxed ordinary income
- surrender charges for early withdrawal
- a 10% penalty (except in very limited situations) for withdrawal before the age of 59½; and,
- lack of ability of non-taxable transfer to charities, or transfers or bequests to anyone but a spouse (as in an estate) because of the IRD nature of the asset. To negate some of these disadvantages, some investment firms are selling annuities with no surrender charges and low selling and administration charges.
Note: Under IRC Sec. 72(u), the income from annuity contracts not held by natural persons is considered taxable ordinary income of the beneficiary. However, the holding of an annuity by a trust or other entity, as an agent for a natural person, is exempt from this provision.
Cash value life insurance and life insurance held by trusts (e.g., irrevocable life insurance trusts) are non-assessable assets.
Caution: Some private colleges do assess life insurance when computing the EFC. The financial advisor should contact each college that the student is interested in attending and inquire about its policy regarding assessment of life insurance.
Some families may find life insurance an attractive way to save for college.
The advantages of this type of investment are:
- non-assessment in the EFC calculation at most colleges
- tax-deferred growth of earnings
- availability of low-interest loans from the policy during college years
- potential earnings of variable life policies to keep up with high college inflation rates
- forced systematic savings by the family for future college costs
- coverage of the future cost of college in the event of death
- coverage of future cost of college in the event of disability, if the policy has a disability insurance feature; and,
- possible protection from creditor claims.
Caution: There are some possible disadvantages to using life insurance as an investment vehicle to save for college.
The possible disadvantages are:
- high selling and administration charges
- conversion of low-taxed capital gains into high-taxed ordinary income in variable life policies
- surrender charges for early withdrawal; and,
- a 10% penalty for withdrawals from modified endowment contracts.
Retirement accounts, such as the 401(k), 403(b), IRA, SEP, and Keogh, are non-assessable assets. The Roth IRA is also not assessed.
Note: Under the Federal Methodology, a Coverdell Education Savings Account (CESA) is considered an asset of the parent. In addition, if the student’s siblings have CESAs and the student is required to file the PROFILE application form, the value of the siblings’ CESAs is assessed at the parents’ rate.
A Roth IRA may be a good college investment option.
The advantages are:
- it is a non-assessable asset in the EFC computation
- the earnings grow tax-free
- early withdrawal of only the contributions will be tax-free
- current year contributions will not prevent a contribution to a tuition prepayment savings plan
- withdrawal from a Roth IRA will not affect eligibility to claim the American Opportunity Credit or Lifetime Learning Credit nor will it reduce the “qualified education expenses” for the student loan interest tax deduction
- no taxability of withdrawals of contributions if used for non-college purposes
- control of the asset remains with the parent
- up to $5,500 per year may be contributed by each parent; and,
- with proper tax planning, the child may be able to contribute $5,500 annually to the child’s own Roth IRA.
Example: Jack and Jill operate a sole-proprietor business. Their ten-year-old child, Ryne, worked in the business on weekends and during his summer school break. Ryne was paid $5,500 per year for this work. The parents received a tax deduction for these wages and because Ryne was under 18 years of age, they were not required to withhold social security payroll taxes on these wages. Since Ryne dreamed of going to college, he invested the $5,500 in a Roth IRA to help cover his future college costs. In addition to the $5,500 Ryne invested, his parents contributed an additional $5,500 each to their own Roth IRA, which can also eventually be used for future college costs, for a total of $16,500 per year.
Some families may consider saving for college through their retirement plans.
The advantages to using this form of college savings are:
- non-assessment in the EFC calculation
- contributions are tax deductible, except in the case of Roth IRAs and non-deductible IRAs
- tax-deferred growth of earnings
- availability of loans from the account, except for some types of retirement plans (e.g., IRAs and Keogh plans) during college years
- depending on the type of account investments, the ability to keep up with the high college inflation rates the account assets are sheltered from creditors
- IRA withdrawals (including Roth IRAs) before age 59½, used for qualified college expenses, are not subject to the 10% early withdrawal penalty; and,
- the employer may match contributions to some plans.
Caution: There are some possible disadvantages to using retirement accounts as an investment vehicle to save for college.
The possible disadvantages are:
- conversion of low-taxed capital gains into high-taxed ordinary income
- a 10% penalty for withdrawals (except in very limited situations) before the age of 59½
- retirement funds needed for future retirement may be depleted to pay for current college costs immediate repayment of outstanding loans may need to occur if there is a job loss; and,
- outstanding loans may be considered withdrawals and produce taxable income and the 10% early withdrawal tax penalty, if they are not repaid within 5 years.
Student loan proceeds put into a bank account and not spent before the following year’s financial aid application is filed are not considered an assessable asset.
Personal items (e.g., cars, clothes, and household items) are not assessed. Debt corresponding to personal items cannot be listed on the financial aid application forms.
Restricted Bank Accounts
Checking and savings accounts that an individual does not have control over or cannot make choices about because of the actions of any state in declaring a bank emergency due to the insolvency of a private deposit insurance fund are not assessable.
The family’s personal residence (The Institutional Method assesses this asset) is a non-assessable asset. Second or vacation homes are assessable assets (including vacant lots that will be used as a future residence site).
Note: If parents consider their motorhome or houseboat to be a second or vacation residence and deduct the interest on Schedule A as residence mortgage interest, they should report the value of this asset and corresponding debt on the financial aid application. If they do not consider these assets to be second or vacation residences, they do not have to be included on the financial aid application form. Temp. Reg. 1.163-10(T)(p)(3)(ii) defines a second residence for interest expense deductibility purposes to include a motor home or houseboat that contains sleeping space, along with toilet and cooking facilities.
The family farm (The Institutional Method assesses this asset) is a non-assessable asset. A family farm is defined as the family’s principal place of residence and meets the “material participation” test listed on Schedule F. Where the family owns all the stock in a farm corporation, materially participates in the farm operation, and has the corporation as the principal place of residence, the assets of the corporate entity are not assessable.
Observation: Family farm partnerships, limited liability companies, and trusts that meet the above criteria also apparently qualify for the family farm asset exclusion.
A farm that does not meet the criteria for a family farm is considered an “investment farm” and must be reported at its current market value. Any corresponding debt should also be reported. Investment farm assets include:
- livestock; and,
Example: Joe and Joan, who are both full-time high school teachers, live in town and also own and materially participate in a farm during the summer months. Since they do not live on the farm, their farm assets are reported on the financial aid application as “investment farm” assets.
Note: If a qualified family farm contains land in two separate locations, the assets of both locations are not assessable.
When filling out the PROFILE form, do not include the farm personal residence with the rest of the farm; list it on the residence line.
There are two unanswered questions regarding the definition of a family farm:
- Does the family have to actually live on the farm or can they have a personal residence in town and still be considered to have a non-assessable family farm? In the author’s opinion, when a bonafide farm family lives off the farm and the family is materially participating in a bonafide farm operation, the assets should still be considered family farm assets and not be assessed. However, the town residence value, and corresponding debt, should be listed as a real estate investment asset on the financial aid application.
- Can the family rent personally owned farmland to a family farm corporation and still have the land considered part of the family farm (versus having the land be assessed as farm investment property)? In the author’s opinion, the personally owned land should be considered part of the family farm and therefore not assessed. The above situation is merely a type of business arrangement and should not obscure the fact that the farm operation in its entirety is a family farm. Some Financial Aid Officers (FAOs) may not agree with this opinion.
Note: The family should check with the colleges where their child is considering attending to determine in advance what the college’s policy is concerning this subject. The college’s policy may be a determining factor on whether to incorporate the family farm before or during college years. If a college considers land rented to the family farm corporation as “investment farm”, a student’s financial aid could be drastically reduced.
Observation: If the FAO questions the above situation and wants reasons to substantiate the parents’ claim that land rented to a family farm corporation is not assessable, the financial advisor could cite the Internal Revenue Service’s position that a landlord farmer materially participates in rental land and is subject to self-employment tax on the rental land. Because self-employment income appears to be the key to the definition of a family farm, this IRS position could be cited as a reason to not assess the farmland as an investment farm asset.
The assets of the student’s siblings are not assessed under the FM. However, the siblings’ assets, including assets in a Qualified Tuition plan (Section 529 plan), will be assessed under the IM. These assets are assessed as parental assets at a 5.6% rate.
Parent’s may want to put some of their assessable assets into a QTP under a sibling’s name. A student’s sibling’s QTP is not assessed under the FM Formula.
If parents had assessable assets, such as CDs, they could contribute the CDs to Qualified Tuition Plans for the student’s siblings. The financial aid result would be moving an assessable asset, CDs, to a non-assessable asset, Qualified Tuition Plan.
Business with less than 100 full-time employees
Businesses with less than 100 full-time employees are not assessed under the FM formula. The business will be assessed under the IM formula.
Assessable assets include all other assets of the parents and the student which do not meet the exceptions for non-assessable assets.
Assets are assessed at their current market value as of the date the financial aid application is signed. The value of an asset cannot be changed from the original signing date of the financial aid application unless the asset was incorrectly reported on the signing date. Stock market fluctuations are not a valid reason to change the value of an asset.
Example: At the date of signing the financial aid application form, the parents owned stock valued at $90,000. However, by the time the student received the Student Aid Report, the value of the stock had decreased to $30,000. Even though the value of the stock had decreased, the stock value listed on the Student Aid Report could not be changed for this market fluctuation.
Observation: The general “rule of thumb” for asset valuation, used by most colleges, is the current market value of the asset if it was forced to be sold within 30 days. The National Association of Student Financial Aid Administrators (NASFAA) uses this rule for their members.
Note: An applicant is not allowed to report a negative net worth on the FAFSA.
Note: A negative asset value can be reported on the PROFILE application form and will be factored into the Institutional Methodology EFC formula.
Asset Protection Allowance
There is an asset protection allowance, a deduction against the gross assessable assets, based on the age of the older parent. By reviewing the EFC formulas, note that the asset protection allowance increases with the age of the older parent. The student does not receive an asset protection allowance; the student’s assets are assessed at a flat 20% on all assessable assets.
EDUCATION SAVINGS & ASSET PROTECTION ALLOWANCE (2018-2019)
Age of older parent Allowance for two parents Allowance for one parent
45………………………………………………. $19,800 $12,000
46……………………………………………… $20,300 $12,300
47……………………………………………… $20,700 $12,600
Business / Farm Discount
Businesses over 100 employees and Investment farm assets are discounted when calculating the EFC. The Department of Education’s processing center will make the actual discount calculations. Therefore, the value of the asset, before the discount, must be reported on the financial aid application form. Note that only “Investment Farms,” as opposed to non-assessable family farms, receive this discount.
BUSINESS / FARM NET WORTH ADJUSTMENT TABLE (2018-2019)
If the net worth of a farm is Then the adjusted net worth is
Less than $1 — $0
$1 to $130,000 — 40% of net worth of investment farm
$130,001 to $390,000 — $52,000 + 50% of excess over $130,000
$390,001 to $655,000 — $182,000 + 60% of excess over $390,000
$655,001 or more — $341,000 + 100% of excess over $655,000
Asset valuation can be a difficult task. The following criteria should be considered in asset valuation:
If the asset could be sold, the value is the estimated selling price (Remember the “forced sale within 30 days” rule of thumb) at the date of filing the financial aid application. The selling price is affected by several factors, such as:
- The size of the asset’s market (e.g., closely held business versus those publicly traded).
- Minority interest in the asset. Minority interest usually allows for a lower valuation of an asset.
- The amount of goodwill and other intangibles included in the asset. For example, a prospective buyer could heavily discount goodwill in a personal service business.
- Future tax liability of the entity may allow for a discount (e.g., corporation tax liability upon liquidation of the corporation).
Observation: When determining asset value to be reported on the application form, a provision for the asset’s associated income tax liability should be considered. Proper financial statement reporting requires that a provision for the future income tax liability of the asset be reported on the financial statements. Therefore, it is logical that an asset’s related future income tax liability be used to reduce the value of the asset.
Example: If the estimated current value of an asset is $100,000 with a tax basis of zero, the reportable value of the asset is only $70,000, assuming a tax rate of 30%. The future sale of the asset will create $30,000 in income tax liability. Therefore, the value of the asset should only be $70,000 ($100,000 gain – $30,000 tax liability), less any corresponding debt.
The collectability of an asset is to be considered. Assets such as accounts receivable, notes receivable, contracts receivable, or mortgages receivable can be discounted due to the question of collectability or rate of interest.
The value of bonds (e.g., EE Bonds or Municipal Bonds) may not be the face value of the bond; the value could be less or greater than the face value.
The value of real estate can be estimated by using the index multipliers provided by the U.S. Department of Commerce. The Housing Index Multiplier and the Commercial Property Multiplier can be used by colleges that use the IM to calculate the EFC, to value residential real estate and commercial real estate, respectively. These tables can be found in Appendix G at the end of this chapter.
Note: The values obtained from the index multipliers should not be used to replace the actual value of the real estate. These tables should only be used as a guide in cases where the value of real estate cannot be easily determined.
Partial Ownership of an Asset
If an asset is only partially owned, only the value of that percentage of ownership should be listed on the financial aid application (e.g., partnerships, corporations). The general rule is that the value of an asset should be divided by the number of people who share ownership, unless the share of the asset is based on the amount invested, or the terms of the arrangement specify some other means of division.
Contested Ownership of an Asset
Assets should not be reported on the financial aid application if the ownership is being contested at the time of filing the application. Even if the ownership of an asset is resolved after the application is filed, the student is not required to update this information.
The following are examples of contested assets:
- Joint assets of separated or divorced parents that are being contested and cannot be sold until the final divorce decree.
- Assets involved in bankruptcy proceedings do not have to be reported on the financial aid application. However, income from proceeds of bankruptcy, foreclosure, or involuntary conversion is still considered in the financial aid formulas.
- Assets involved in lawsuits or judgments do not have to be reported.
The following are examples of non-contested assets:
- Liens Against an Asset. If there was a lien or imminent foreclosure against an asset, the asset would still be reported until the party holding the lien or making the foreclosure has completed legal action to take possession of the asset. Tax liens would fall into this category.
- Assets that are being purchased by a family on a “Contract for Deed” are assessed.
- Assets subject to a “life estate” are assessed. Due to the restricted use of these assets, the value of the asset could be discounted.
- Assets involved in probate (and not being contested) are assessed.
Example: The student’s parents were beneficiaries of a grandparent’s estate. Even though the assets were included in the probate proceedings and the parents could not gain access to the assets during the upcoming college year, they still must report the assets on the student’s application form.
Trusts and Custodial Accounts
Trust and Uniform Gift to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA) assets should be reported on the financial aid application at their present value, even if the beneficiary’s access to the trust is restricted. In the case of divorce or separation, where the trust is owned jointly and ownership is not being contested, the property and the debt are equally divided between the owners for reporting purposes, unless the terms of the trust specify some other method of division. Trust assets do not have to be reported when they are restricted by court order for a specific purpose (e.g., future medical expenses of an accident victim).
Note: There may be some adverse legal and tax consequences to pulling assets out of a trust or UGMA/UTMA and putting them in another person’s name. It may be illegal to take money out of a trust account and not use it for the benefit of the beneficiary. The transfer of money out of a trust may be considered a taxable gift to the transferor or taxable income to the person receiving the money. These consequences must be investigated before transferring monies out of the child’s trust or UGMA/UTMA account.
Observation: In an attempt to qualify for Medicaid, grandparents often shift assets to their grandchildren (via trusts and custodial accounts). The grandparents should be made aware of the effect that this strategy has on the financial aid eligibility of the grandchild.
The way in which a trust must be reported varies according to whether the student (or the dependent student’s parent) receives or will receive the interest income, the trust principal, or both. If a student or parent receives only the interest from the trust, any interest received in the base year must be reported as income. Even if the interest accumulates in the trust and is not paid out during the year, the person who will receive the interest must report an asset value for the interest to be received in the future. The trust officer can usually calculate the present value of the interest the person will receive while the trust exists. Should the student or parent receive only the trust principal, the individual must report the present value of the future right to the trust principal as an asset. Again, the trust officer can calculate the present value. If the student or parent will receive both the interest and the principal from the trust, the present value of both interest and principal would be reported, as described above.
Trust Trap Problem
Since one of the most popular methods of saving for college is through trusts or custodial accounts and student’s assets are assessed at a 20% rate versus the parents’ 5.6% rate, this method of savings can create a financial aid problem for the student. Following are possible solutions to the problem of having trust assets in the student’s name.
Spend for the Student’s Benefit
Spending the money for the benefit of the student may be a solution to the trust trap. Examples would include purchase of a vehicle, computer, K-12 private education expenditures, or college expenditures.
Example: The student’s trust buys a college car for the student instead of having the parents purchase the car for the student.
Note: If income from custodial property is used to offset a parent’s obligation to support a child, the parent is taxed on that income. The result is the same whether the parent with the support obligation is the custodian or not.
A student who has funds in a custodial account may consider not filing the financial aid application form until after the student turns of legal age, which is 18 in most states. The student can make a legal gift of the trust funds to non-college family members and therefore, legally reduce assets.
Converting from Assessable to Non-assessable Assets
Converting the trust’s assessable assets into non-assessable assets may be a solution to the trust trap. The financial advisor should recommend a no-load, no-surrender charge annuity to the client. This type of annuity is preferred if the client plans to use the annuity to pay off college loans after college years. Before recommending this strategy to the client, the financial advisor should check with the college to make sure the college does not assess annuities in the IM formula.
Example 1: A trust custodian could purchase non-assessable annuities or life insurance with the trust assets.
Example 2: A trust custodian could use trust funds to purchase a personal residence for the student in the town where the student’s college is located. If the student uses the house as a personal residence, the residence will be treated as a non-assessable asset under the Federal Methodology EFC formula. If the student rents out part of the house, that portion of the house will be considered an assessable real estate investment asset. Upon leaving college, the student could sell the house and not be taxed on any gain on the sale, assuming the requirements of IRC Sec. 121 are met. Remember, the Institutional Methodology EFC formula does assess the personal residence.
Qualified Tuition Plans
Qualified Tuition Programs (QTPs) are state sponsored trusts used to save for future tuition, related fees, and room and board costs at a particular university system or college. There are two basic types of QTPs, the “prepaid tuition plan” and the “college savings plan.” These plans are described in the following sections.
Prepaid Tuition (529) Plans
These state-operated trusts offer residents a hedge against tuition inflation. States offer contracts whereby they agree to pay future tuition at in-state public institutions at prices pegged to current tuition levels. Some state contracts incorporate a further discount derived from a share of the program trust fund’s projected future investment gains in excess of anticipated tuition increases. While prepaid tuition plans are designed to eliminate the risk of tuition inflation, some sponsoring states do not guarantee the contract. This means that in a worst-case scenario, a poor investment climate combined with a lack of accumulated reserves could threaten the solvency of a program trust fund.
College Savings (529) Plans
Essentially a state-sponsored mutual fund, the basic idea of a savings plan is that the account owner’s contribution will grow in value over time, keeping up with or surpassing the escalating price of a college education. Inherent in savings plans, however, is the risk that the underlying investments may not keep pace with tuition increases. Many savings plans manage this risk by investing the accounts more conservatively as the designated beneficiary approaches college age. Withdrawals are taken as needed to pay for the designated beneficiary’s college expenses.
Most new QTPs are savings plans; these are generally judged superior to prepaid tuition plans. Savings plans offer more flexibility than prepaid tuition plans, and their investment approach can provide upside potential from the stock market. Several states have plans that are open to residents and nonresidents alike. In the future, it will not be unusual to find families with accounts in several different savings-plan QTPs at the same time.
Financial Aid Treatment of College Savings Plans
- College savings plans are assessed as an asset of the parent at a rate of 5.6%, if the parent is the owner of the plan.
- If a person other than the student or the student’s parent owns the plan, it is not assessed in the EFC formulas.
- If a custodial account of the student is the owner of the plan, the assets of the plan are assessed as an asset of the parent at a rate of 5.6%.
- The income generated by distributions from the plan is not assessed as income of the student; and the principal portion withdrawn also has no impact on college financial aid.
- Under the IM formula, college savings plans are treated as an asset of the parents if the account is owned by either the student or parent.
Summary of Asset Strategies
The financial advisor must categorize the client’s assets into assessable assets and non-assessable assets. To correctly enter the asset data into the EFC estimator, the financial advisor must understand the rules of which assets are assessed and how they are valued.
Since trust and custodial accounts are the most common methods of accumulating college funds in the child’s name, the financial advisor should be aware of strategies that can minimize the negative effect of these accounts on a child’s financial aid eligibility.
Qualified Tuition Plans are currently the “hottest” way to save for college. Therefore, the financial advisor needs to analyze the pros and cons of these investments. Since most states offer plans with variable features, it is imperative that the financial advisor analyzes both in-state and out-of-state plans.
In order for the financial advisor to select asset strategies, both the current and projected assets must be determined.