This is part 2 of our mini series around college savings and financial aid. As part of these we have a guest post from our Podcast guest, Jack Wang.

For most Americans, “doing” taxes each year simply involves filling out the required tax return(s) and hoping for a large refund.

In many ways, families think the same way about college financial aid. The “tax return” is called the FAFSA, or Free Application for Federal Student Aid. It looks like a tax return, and uses much of the same information.

But aid goes well beyond willing just out a form.

What are the types of aid?

There are two basic kinds of aid for college - merit aid and need-based aid.

Merit is as the name suggests. It is based on characteristics of the student, such as grades and test scores, or athletic or artistic ability. Typically, merit aid is in the form of scholarships and does not need to be paid back. There are different conditions to get, and maintain, a scholarship. And not all scholarships cover multiple years.

Need-based, on the other hand, is based on the financial information provided on the FAFSA as well as the CSS Profile, which is required by the upper tier privates and Ivy League class of colleges.

Need-based aid can take many forms, including:

• Grants - which does not have to be paid back
• Loans - which do have to be paid back
• Work study - which is a paid on-campus job

These types of aid can be from the Federal government, state and local government, or the colleges themselves. Some of the upper tier private schools will offer their own loans, while other colleges are “no loan” which means they do not offer any loans in their aid packages. Colleges can include all or some of these aid items for various dollar amounts for students.

For Federal aid, families may be eligible for:

• Pell grant - up to $6,495/yr
• Supplemental Educational Opportunity Grant (SEOG) - up to $4,000/yr

Both the Pell and SEOG programs are for low income families, typically measured as a percent of the Federal poverty level for a given family size.

•  Subsidized Direct loan - up to $5,500/yr based on academic year

A Direct loan is a loan to the student, no cosigner or credit check necessary. A portion of the loan may be subsidized, which means that loan interest does not accrue while the student is in college.

• Federal Work Study - typically up to $3,000/yr

This is usually an on-campus job that pays at least the minimum wage. Earnings from this job do not hurt financial aid eligibility.

What are the sources of aid?

Given the importance placed on completing the FAFSA in the news - including eight states that mandate FAFSA completion for high school students, families often think the biggest source of aid is the Federal government.

They are correct. And not correct.

While filling out the financial aid form is important for all families, the reality is that most aid is provided by the colleges themselves - and not just from the ones that have the biggest endowments.

According to the College Board Trends in Student Aid Report 2021, the Federal government was the largest source of college aid, totaling $146 billion. But that doesn’t tell the whole picture. Of that total, $91B was in the form of loans to students and parents. That means $55B was in the form of grants, work-study, and Veterans Administration benefits.

Colleges, per the same report, provided $69B in aid themselves.

The amount of aid a college provides has no correlation to the size of the endowment. While the large endowment schools, such as those part of the Ivy League, get the majority of the press, colleges use aid - in whatever form - to try to attract students. A scholarship simply represents the willingness to offer a discount, much like a retailer putting items on sale.

For the colleges that use both the FAFSA and CSS Profile form, the purpose of the forms is more clear. At these schools, the FAFSA only governs Federal aid while the CSS Profile form helps the college allocate institutional aid, that is, their own money.

Their money, their rules.

What year counts for financial aid?

Financial aid forms consider two factors - income and assets.

Values of assets simply count as of the day you complete the financial aid form.

Income is a two year look back. For example, for a student who will be a high school senior in Fall 2022:

• Attend college in Fall 2023
• Fill out financial aid form in Fall 2022
• Use most recent tax return, which would be 2021

Hence, the prior prior year terminology - attending college in 2023 would look at the tax return for 2021.

Similar to a tax return, financial aid forms report what has already happened. This means that planning for financial aid has to take place earlier than most families think.

Just as there is no magic bullet to saving taxes, there is no magic bullet for getting a lot of financial aid.

What does this all mean?

Most families play the game of financial aid without knowing the rules. It would be hard to win any game without knowing the rules. No wonder families think financial aid is a big black hole mystery.

Also, for most colleges, the line between merit and need-based is not a hard line separating the two. The reality is that even high income families can qualify for need-based aid under the right circumstances.

Making this even more difficult is that there are over 4,000 colleges and universities in the US. And they all do something slightly different regarding aid. Colleges are more than happy to have you pay full sticker price, which can top $80,000 per year.

Understanding and thoughtful planning can reduce costs substantially and make college affordable for many families.

Bottom line: You have to know the rules to win the game. 

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