This article is from the Financial Aid, Scholarships, and Fellowships FAQ, by Mark Kantrowitz with numerous contributions by others.
The FinAid site also includes a list of tips on how to arrange your
finances so as to maximize your eligibility for need-based financial
aid. Here's just a taste of FinAid's analysis.
1. The parent contribution is divided by the number of children
in college. Changes in the number of family members in college can
significantly affect the amount of aid received. For example, even
families that are well-off may become eligible for financial aid
when two or more family members are enrolled in college at the
same time. So parents should not assume that they are ineligible
for aid just because they make too much money or own a house.
2. The assets and income of parents are "taxed" by the federal
methodology need analysis formula at a much lower rate than those
of the student. This means that it may not be to the advantage of
the parents to shift income and assets to their children, despite
the tax savings. Generally, no more than 5.64% of a parent's
assets (excluding their home equity and retirement programs) are
expected to be used for the child's educational costs. For most
parents, the first $40,000 or more of their assets (depending on
their age and family size) will be ignored completely in the
federal methodology need analysis formula. On the other hand,
student assets are "taxed" at 35%, a much higher rate. This
suggests that college funds should be saved in the parents' names
and not the child's (the difference in aid eligibility wipes out
any tax savings from Uniform Gift to Minors Act asset transfers),
and spend down the student's assets before using any of the
parents' assets to pay for the student's education.
3. The financial aid award or "package" is based on the assets and
earnings for the year before the student matriculates in
college. So parents should be careful about financial activity the
year before their children enter college. For example, parents who
avoid creating capital gains during the child's senior year in
high school will be at an advantage in the federal methodology
need analysis system. Likewise, they may wish to wait until after
the child has entered college to withdraw money from pension plans
to pay for college expenses.