Expected Family Contribution (EFC) is a formula used to determine how much of a family’s income and assets will be used for annual college expenses. The higher your EFC, the more you will pay out of pocket. EFC is calculated from the information provided on the FAFSA form. Many families mistakenly assume this is only important for government based financial assistance. Most colleges and universities also distribute financial assistance from their own private resources using the EFC (or a variation). It is important to avoid common mistakes that can inflate your EFC.
· Do not have accounts in the student’s name. Individual accounts or UTMA accounts increase EFC more than any other type of asset.
· Be aware that the student’s earned income will inflate EFC. Unfortunately, students who work hard and earn money could be penalized.
· The following financial transactions will increase your EFC: Realized capital gains, Roth IRA conversions, sale of property or business, or IRA distributions. Try not to time these transactions so that they occur in the calendar year prior to your student’s enrollment. Also, if you plan on using proceeds from stocks or mutual funds to help pay college expenses, consider selling these assets while the student is a sophomore if there are capital gains.
· The following financial transactions will decrease your EFC: Realizing capital losses, paying off credit cards or auto loans, moving the student’s assets into 529 plans, maximizing your IRA, Roth, or 401(k) contribution.
Retirement accounts such as IRA’s and 401(k)’s do not count in the EFC formula. The contributions made in the prior calendar year do get added back into your income causing your EFC to increase. Also, if you have a major purchase in the near future, you might consider making that purchase just prior to completing your FAFSA if you are able to use existing assets.
Do not ignore the importance of this type of planning. Some simple steps can take pressure off the family budget and reduce the need for student loans. Ideally, parents should start reviewing this four to five years prior to their child’s enrollment. That being said, it is never too late to start.