When it comes to college financial planning, divorced parents encounter unique challenges and issues.
You will make lots of big financial decisions during the course of your divorce. Many of these decisions will impact what information will end up on the FAFSA. The FAFSA (Free Application for Student Aid) is used to apply for federal financial aid.
If cooperation is possible, there are strategies that can help maximize college financial aid and lower the financial burden of college.
College Financial Planning Before the Divorce Is Final
Oftentimes college financial planning isn’t addressed in divorce negotiations, which can be a costly mistake. We recommend spelling out as many of the college financing issues as possible in the divorce agreement. Which spouse is responsible for paying for college and for what costs, in particular, will they cover? How many semesters will they cover, and up until what age? Are payments dependent on academic requirements?
Clearing up the answers to these questions can prevent conflict and confusion later on. The reality is that the proper planning in this area often doesn’t get addressed given that the parties are at odds during this time.
Maximizing Financial Aid for Your Children After Divorce
Proper coordination and planning can help children of divorced parents maximize college financial aid. For the FAFSA, only the custodial parent — the parent that the child spends the majority of the year with — reports their income and assets. Note the custodial parent has nothing to do with which parent claimed the child on their tax return as a dependent. CSS schools on the other hand look at income and asset data from both the custodial and non-custodial parents. If parents split time with the child equally, it may make sense to tip the scales and designate the less financially secure spouse as the custodial parent to maximize financial aid.
Planning Strategies During Divorce Negotiations
A prudent college financial aid strategy could mean the custodial parent receiving more of the home and less alimony, or perhaps timing the receipt of alimony outside of years that affect Effective Family Contribution (EFC). Many divorce settlements set up education trusts for college education, but this can backfire down the road since these accounts are classified as student assets and are penalized heavily under the financial aid formulas.
Likewise, if the child has assets in a UTGA or UGMA account, you may want to transfer those funds into 529s to get them assessed as parental assets, or you can simply spend that money on college expenses before other funds. Perhaps it makes sense to spend the UTMA/UGMA money ahead of college on tutoring or computers.
529 Plan Strategies
Some careful thought should be done around funding college expenses with 529 plans. You want the non-custodial parent to hold this asset to minimize its impact on the financial aid formulas. Distributions from 529 plans can lower financial aid eligibility, so holding off on using these funds until non-assessable years (Junior and Senior years) is ideal.
Distributions from 529s held by grandparents should also be delayed until the later college years since they are considered the child’s income under the formulas. If grandparents want to contribute in the early college years, we suggest transferring the 529 or other assets to the parents or paying for items directly like computers or airline tickets. Another strategy is for grandparents to simply make student loan payments later down the line.
Unintended Pitfalls in College Financial Planning
Various actions by divorcees can have unintended consequences on financial aid eligibility. Selling the family home can reclassify non-assessable home equity as assessable cash. If the custodial parent gets remarried, the new spouse’s assets and income now become scrutinized by the FAFSA, and could lower your financial aid eligibility.
If the custodial parent has an interest in taking classes at a local community college, one strategy could be to enroll at a local community college. Doing so will increase college financial aid eligibility since the EFC formula is now divided by more “students” under this strategy.