Which Assets Matter Most in Financial-Aid Formulas?

It's never too early to start thinking about financial aid for college if you have children. In fact, the sooner you learn the process, the better. That's because how you save for your child's education can affect the aid the you receive.

According to the October issue of Kiplinger's Personal Finance magazine, you have to save strategically if you hope to qualify for financial aid. Here's what you need to know about how financial-aid formulas weigh assets in parents' names versus a child's name:

Parental assets. The federal financial-aid formula expects parents to contribute no more than 5.6% of their savings to college costs, and it keeps some assets out of the equation altogether. Private colleges use a different formula for calculating your contributions, but the percentage from savings is similarly small. In both cases, income has a far greater impact on financial-aid eligibility than parent-owned savings do. The federal financial-aid formula and most private colleges ignore assets in retirement accounts but consider distributions from the accounts as untaxed income in the year you withdraw them.

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Child-owned assets. Child-owned assets are treated less gently. The federal formula assesses those accounts at 20%; the institutional formula, at 25%. For financial-aid purposes, you're better off saving in parent-owned accounts, which generally include 529 savings accounts, prepaid tuition accounts and Coverdells. UGMA and UTMA (custodial) accounts belong to the child, but you can transfer the money to a custodial 529 to qualify for the parents' lower assessment.

Grandparent-owned assets. The federal formula ignores assets in grandparent-owned 529 plans and cash-value life insurance but counts the distributions as income.

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