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FAFSA-EFC-Taxes

This was originally posted 6 May 2006 on the Increa Technology Blog. An updated and expanded version is posted here, including a do-it-yourself spreadsheet to see the effect of FAFSA numbers on your EFC. Although you can study the spreadsheet to understand the calculations, you can also do "what if" games to see how to minimize your EFC.

FAFSA and EFC, combined with taxes are a scary combination! FAFSA and EFS are terms any parent sending a child to college needs to know very well. This pair is suppose to open a door to affording a college education. Instead, it's become a socialized method of redistributing wealth, with so many political hooks that it's worse than IRS tax forms or government security clearances.

Be prepared: this process is very invasive. It used to be the FAFSA was only for Federal Aid. Literally, that's still true. However, given a standard to follow, most colleges now require you to fill out the FAFSA in order to apply to local college money. In other words, you can't avoid it unless you straight-up pay the entire bill out of pocket. Even working on campus requires you to demonstrate "need" so you don't take a job others need. (Did someone forget to mention work skills? No, that's not a requirement to work on campus any more — all you have to do is demonstrate financial need. Sorry, that's my angst showing..)

FAFSA stands for Free Application for Federal Student Aid. Most people pronounce this "Fasfa" because otherwise it's a nearly impossible tongue twister. This is the multi-page form you have to fill out and give to the college and to the Federal government. They use the numbers you provide to calculate your EFC. It's more invasive than IRS tax forms because they want not just your cash flow rate, but also your cash savings. Of course, if you've saved a lot, you're penalized compared to others.

EFC stands for Expected Family Contribution — that's how much money your family is expected to provide for a college education. Hopefully (but not always), the rest of the college cost can be made up with Financial aid. Financial aid isn't really free money the way people use the term these days. Financial aid may include grants, scholarships, and federal loans. In fact, at most colleges, if a student is allowed to work on campus, then that counts as financial aid, too. EFC is basically what Mom, Dad, or the student are expected to provide each year. Your EFC is spread out over the number of children attending college.

The college will try to make up the difference between total costs and EFC with an aid package. If you are a potentially attractive student (athletics, grades, minority status, etc), schools will usually make up the difference or even give more. If you are not one of the special categories, you will be "gapped". In other words you have a gap to fill even more than your EFC.

The idea is that you enter all your private financial information in the FAFSA web page, and then using formulas described in the EFC booklet, out pops the number your family is expected to contribute to your children's college costs. Dare I even open the idea of invasion into what used to be a private family relationship between parent and child? This is the cost of accepting money from others.

The EFC is not dependant on how much a college costs, $45,000 per year or $9,000 per year. If the college cost is more than your EFC, the colleges do a really good job of getting you 1) grants, 2) scholarships, 3) federal loans, or 4) authorized work on campus until what's remaining for you to pay is equal to your EFC.

I was surprised at how large the EFC number is, so I started playing guessing games with the formula, testing out what would happen if I earned more or less money. I was surprised, and you will be, too! Try my EFC calculation spreadsheet, and let me know what you think. The terminology on the spreadsheet is taken from the FAFSA form. It's always good to have a paper copy filled out before you go to the web page. The spreadsheet is from a few years ago. Here is a paper copy of the 2011 FAFSA form in pdf form.

Heads up for a scary realization. If you don't understand the concept of marginal taxes, please do a web search on "marginal tax rate" and then this will make more sense to you. Will you go get a better job to pay for you child's college? Forget it. Here is the break-out of where an extra $1000 goes if you live in California and get a raise:
250.00 Federal Taxes
  93.00 State Taxes
  72.50 Sales Tax
  62.00 Social Security
  14.50 Medicare
   8.00 CA State Disability
-----------------------
 500.00 gone to taxes

So $500 instantly goes away. The EFC marginal tax rate is 47% for anybody reporting more than $26,000 annual income, so you're expected to spend $470 on college expenses, and you'll get $470 less in assistance. Check Table A6 in the EFC documentation linked above if you don't believe this number.

In the $1000 example, this leaves you with $30 for non-college expenses. I want to re-state this again for clarity: if you earn $1000 more, you'll spend $470 more on college expenses because the colleges will help you $470 less. $500 of it went to taxes. You'll have $30 left for anything else.

So out of $1000, I get to keep $30. Why not earn a lot less and let the government pay for college? I'm done with overtime hours! This is a serious de-motivator to earn more money or get a better job! What are the federal legislators thinking? Don't get a better job or a promotion during college years! While children are in college is a time to build vocational capital and enjoy life with your children - NOT earn more money.

I ran the above example with 25% Federal tax bracket because that captures the actual Median Household Income in the years 1995 on up to today (bracket is $31K to $74K per year). If you make $74K to $155K per year, the Federal tax jumps to 28% and you get to keep none (zero dollars) of the hypothetical $1000 raise for non-college expenditures. If you are in a higher bracket, you actually loose money if you earn more!

I include sales tax in the calculation because nearly everybody spends the money they make each year. During college years, you'll be lucky to not work in the red (spending more than you make). But if you're really disciplined and stash all the money in the bank so that you're not exposed to sales tax, you can keep the 7.25% I attributed to sales tax.

Well sort of. The EFC formula also measures how much you have saved in the bank, taking 5.6% toward college. See Line 23 on Page 9 of the EFC document linked above. If you try to save all of your pay raise, then pay taxes, and pay for college, you'll be left with 4.65% or less in the bank.

Yippee.

My less-than analytic thoughts on the FAFSA/EFC/Financial Aid game:
  1. Cost comparison shopping for a college is discouraged, because financial aid is designed to make up the difference for whatever school you can and want to attend. What you want the government will fund.
  2. Penalizes families that are responsible and save money.
  3. Demotivates (and actually forbids on campus) enterprising work income.

Created by brian. Last Modification: Tuesday 14 of February, 2012 12:23:03 EST by admin.