By Rachel Louise Ensign, The Wall Street Journal
What do last year's bonus, your kids' straight As and the money Grandma socked away for their education have in common?
They can all hurt your chances of landing financial aid.
After handing out lots of free money to families at the height of the recession, colleges are tightening their criteria for aid. They're looking much more closely at the financials parents lay on the table -- and it's all too easy to make a misstep that costs your family thousands of dollars a year in assistance. More than ever, you need to know what colleges want to see and how to make yourself look as deserving as possible.
It takes a lot of work to cover all the bases of financial aid. But putting in the effort can save you a heap of money up front -- and keep your child from becoming yet another heavily indebted college graduate.
Here's a look at the some of the biggest mistakes families make in the aid process, and the best ways to steer clear of them.
Earning too much at the wrong time
Many parents wait until late junior year or early senior year to start thinking seriously about college. But by then, you may have blown your best chance to position yourself for the most aid.
Why? Your "base income year" is already well under way.
The Free Application for Federal Student Aid, which determines your eligibility for federal help and aid from many schools, is based on your family's tax return for the year before the child enrolls in college. In other words, if your child plans to start college in fall 2013, schools will look at your return for 2012 -- the base income year.
Many people don't realize this, and don't take any steps to adjust their income, the biggest factor in determining aid. Experts urge families to get an early start and keep their earnings as low as possible during that year. Post continues after video.
For instance, take any big windfalls, such as capital gains or the sale of a property, before the Jan. 1 when your child is a high-school junior, says Mark Kantrowitz, publisher of financial-aid website finaid.org. If you own a business, you may want to defer compensation or take a lower annual salary.
"Every $10,000 reduction in income is going to improve your aid eligibility by [about] $3,000" if you have one child in college, says Kantrowitz. In other words, if you're the sole breadwinner with one kid in college and cut your pay to $100,000 from $150,000, your child will be eligible for about $15,000 more aid annually. (This is a simplified rule of thumb that doesn't apply in all cases, he says.)
Still, you don't want to overdo it. The Internal Revenue Service may come after you for not paying yourself a fair wage, and "the colleges don't like it when someone is rich but appears poor," says Kantrowitz. They may pull back on their institutional aid if they decide your family doesn't actually need the help.
About 250 mostly private colleges also ask parents to fill out a supplemental form called the CSS/Financial Aid PROFILE for awarding institutional funds.
Letting the wrong family members hold college money
Not all family members' assets are considered equal by colleges in the standard federal aid formula.
For one thing, a child's income and assets count heavily against their potential aid. Every dollar a child has in assets -- that includes bank accounts or trust funds -- cuts their possible award by 20 cents. Every dollar a child makes in income above $6,130 (the limit for 2013-14 aid) cuts their possible award by 50 cents.
Before the base income year starts, parents should transfer the child's assets -- that includes any money in checking and savings accounts -- into a 529 plan, a tax-advantaged savings account for college, says Kantrowitz.
Money held in a 529 belonging to a student or custodial parent reduces the student's eligibility for financial aid only up to 5.64% -- meaning an account with $10,000 could knock off a maximum of $564 in aid.
But families should be careful about letting relatives other than custodial parents -- like grandparents, aunts and uncles -- set up 529s for kids. Every dollar a student gets from a 529 plan owned by other relatives is considered income to the student and reduces potential financial aid by 50 cents if the student is above the income threshold, says Kantrowitz. A $10,000 withdrawal would reduce aid eligibility by up to $5,000.
Making assumptions about what schools will offer
When figuring out where your child will apply, don't just guess what schools might offer in aid. Colleges make it easy to figure out how much they're likely to give, with net-price calculators on their websites.
You input financial data like your income, assets and family size, and the calculator spits out an estimate of what you'll pay for tuition, fees and room and board, minus any estimated grants or scholarships. They generally don't factor in things like loans or work study.
By using these calculators, some families will find that generous private colleges may cost them less than their in-state public university, says Robert Weinerman, senior director of college finance at consulting firm College Coach and a former financial-aid officer at the Massachusetts Institute of Technology. That's because the Harvards and Yales of the world give many low-income students a nearly full ride, and many midtier schools give desirable students a lot of money off the sticker price to get them to attend.
Still, there are a number of questions about the accuracy of these estimates; for one thing, some use two-year-old data to make their calculations. That's why it's crucial that your child applies to a "financial-aid safety school," such as a state university, that you'll be able to afford with no aid at all, says Kantrowitz.