Financial Aid

Financial aid is money distributed primarily by the federal government and colleges in the form of student loans, grants, scholarships, and work-study jobs. Loans must be repaid, while grants and scholarships do not. A student can receive both federal and college aid.

Financial aid can be further broken down into two categories: need-based, which is dependent on your child's financial need, and merit-based, which is awarded on the basis of academic, athletic, musical, or artistic merit.

Both the federal government and colleges provide need-based aid. For colleges, need-based aid comes from a college's endowment, and policies may differ from year to year and from college to college, which may result in an uneven availability of funds.

Colleges are the main source of merit aid, and they often use favorable merit aid packages to attract the best and brightest students to their campuses, regardless of their financial need. Every college has a net price calculator on its website that you can use to get an idea of how much aid (need-based and merit) your child might be eligible for at that particular college. If you're a family of means researching college options, one of the things you can do to help your bottom line is to target colleges that offer significant merit aid packages.

The financial aid impact

The college savings decisions you make can impact the needs-based financial aid process. Come financial aid time, your family's income and assets are assessed to determine how much financial aid your child is eligible for. The federal government uses the FAFSA (Free Application for Federal Student Aid) to determine eligibility for federal aid programs, while private colleges use the CSS Profile (or their own specific form) to determine eligibility for college aid programs (public colleges typically just use the FAFSA). This process is called needs analysis. Your income is the most important factor, but your assets count too.

Note: The 2024–2025 FAFSA replaces the term "expected family contribution," or EFC, with "student aid index," or SAI. The change is an attempt to clarify what this figure is: an eligibility index for student aid, not an exact dollar amount of what a family can or will pay for college.

The difference between your student aid index and the cost of attendance at any given college equals your child's financial need. Your child's student aid index remains a constant, but the amount of your child's financial need will vary depending on the cost of attendance at the underlying college.

Under the federal methodology, student assets are weighed differently than parent assets. Students must contribute 20% of their assets each year, while parents must contribute 5.6% of their assets. For example, $10,000 in your child's bank account would equal an expected contribution of $2,000 from your child ($10,000 x.20), but the same $10,000 in your bank account would equal an expected $560 contribution from you ($10,000 x.056).

Under the federal rules, 529 plans and Coverdell ESAs are generally considered parental assets if the parent is the account owner. This is also true for mutual funds, stocks, bonds, U.S. savings bonds, certificates of deposit, real estate, and any other investment that may be owned by the parent. Exceptions under the federal methodology are retirement plans (e.g., 401(k) plans, Roth IRAs) cash value life insurance, and home equity — these assets are never counted, even if they are owned by the parent. By contrast, a custodial account is classified as a student asset.

If a grandparent is the account owner of a 529 plan or Coverdell account, the account isn't counted as an asset at all on the FAFSA. And starting with the 2024–2025 FAFSA, withdrawals from these accounts are no longer counted as student income on the FAFSA. (Withdrawals from parent-owned 529 plans and Coverdell accounts were never counted as student income on the FAFSA.)

How much should I rely on aid?

Many parents assume that financial aid will do most of the heavy lifting when it comes time to paying for college. But all financial aid isn't created equal. Grants and scholarships are great because they are essentially free money. But loans are quite different. Parents and students who rely mainly on loans to finance college can end up with a considerable debt burden that can have significant negative implications for years after graduation. So aim to borrow wisely.