To apply for federal financial aid, you are required to report nearly all of your assets on the Free Application for Federal Student Aid (FAFSA). Some assets are excluded from the calculation of the Expected Family Contribution (EFC). However, the FAFSA’s Federal Methodology contains provisions for an asset protection allowance in attempt to ensure that at least some minimum amount of your assets is excluded from the EFC calculation. In other words, the government assumes those assets will not be used for college.
What is the Asset Protection Allowance?
The asset protection allowance is set annually by the U.S. Department of Education. It is intended to approximate the difference between Social Security retirement benefits and average household income for “moderate income” families, as determined by the U.S. Bureau of Labor Statistics. Asset protection allowances are provided to enable households, in theory, to purchase annuities to fund the portions of their retirements that Social Security benefits do not cover (instead of contributing to kids’ college education). Asset protection allowances are provided to the parents of dependent students (but not to the dependent students themselves) and independent students.
How are Asset Protection Allowances Calculated?
The asset protection allowance for parents varies based on the number of parents in the household and the age of the oldest parent. The asset protection allowance for independent students varies based on the age of the student and whether or not the student is married. The asset protection allowance is the same for single-parent households and unmarried independent students, and for two-parent households and married independent students.
Understanding Reportable Assets on the FAFSA
The FAFSA’s Federal Methodology subtracts an asset protection allowance from your reportable assets. Assets held in retirement accounts are automatically protected, because they are not reported on the FAFSA. The following types of accounts are excluded from your reportable assets:
- 401(k) plans;
- 403(b) plans;
- Individual Retirement Accounts (IRAs);
- Simplified Employee Pension IRAs;
- Roth IRAs;
- Savings Incentive Match Plan for Employees IRAs;
- Keogh plans;
- Profit-sharing plans; and
- Employee pension plans.
The FAFSA requires you to report all assets held in the following types of accounts:
- Checking accounts;
- Savings accounts;
- Certificate of Deposit accounts;
- Brokerage accounts;
- Money market accounts;
- Investment real estate holdings;
- 529 college savings and prepaid plans; and
- Trust fund accounts, regardless of whether the funds are currently available.
Impact of Reportable Assets on Expected Family Contribution
The sum of your reportable assets minus your asset protection allowance (if any) equals your “discretionary net worth.” The discretionary net worth figure is multiplied by an asset conversion rate to arrive at your “contribution from assets” number, which is added to your Expected Family Contribution.
Asset protection allowances are standardized based on age and the number of adults in a household. However, in accordance with the FAFSA’s Federal Methodology, different types of applicants are subject to different asset conversion rates. The following asset conversion rates are for the 2019-20 school year:
- Dependent students: 20 percent;
- Parents of dependent students: 12 percent;
- Independent students without children: 20 percent; and
- Independent students with children: 7 percent.
The Federal Methodology generally does not change from year to year; however, inputs such as asset protection allowances and asset conversion rates are subject to annual revision. The EFC Formula for the 2019-20 school year, including the asset protection allowances available to different types and ages of applicants, is available here. Check it out!
Why are Asset Protection Allowances Shrinking?
Asset protection allowances are unfortunately in steep decline. Average Social Security retirement benefits have been rising while household incomes for “moderate income” families have stagnated. As a result, asset protection allowances have been shrinking quite dramatically. The asset protection allowance for a married parent who is 48 years old, which is the median age of parents of college-age children, was $52,400 for the 2009-10 school year and is just $11,900 for the 2019-20 school year - a 77 percent reduction over just ten years! Unless corrective legislation is passed by the U.S. Congress, asset protection allowances are expected to be eliminated within the next five years.
What Can I Do to Protect My Assets?
You may be wondering what, if anything, you can do to minimize your reportable assets on the FAFSA, especially since the asset protection allowance is dwindling. While none of these are fantastic options, you do have a few viable alternatives:
- Utilize your assets to pay down any debt that you may have;
- Maximize your retirement plan contributions, ideally for several consecutive years before your child is college-age; and
- Aggressively fund 529 savings plans and Coverdell Education Savings Accounts. These tax-sheltered education savings accounts are held in your child’s name but are reported on the FAFSA as a parent asset. As a result, they are subject to the more favorable asset conversion rate for parents, which is substantially lower than the asset conversion rate for dependent students.
The Bottom Line
Only Congress, unfortunately, can effectively address the trend of shrinking asset protection allowances. Short of Congress passing corrective legislative measures, your best and safest courses of action are to pay down debt, fully fund your retirement accounts, and generously contribute to education savings accounts for your child. Asset protection allowances may soon be a thing of the past.