Basing financial aid on family assets is a mess

Measuring assets in aid calculations won’t be abandoned - but it should be.

The FAFSA and CSS Profile financial aid filings’ questions about family assets are unworkable, ask impossible-to-answer questions, undermine the credibility of financial aid offices and their colleges, and penalize savers.  But aside from that, they’re ok.

Though income forms the biggest part of financial aid assessment of need, parent and student assets also have a significant impact within formulas – and the role of assets looks poised to grow in the new FAFSA, due to be released shortly, for families with income over $60,000.  The assessment incorporates everything from taxable bank and brokerage accounts, the net value of farms, businesses and real estate investments, trusts and, in the case of the CSS, home equity, tax-deferred retirement assets and insurance cash values.  This is all a terrible idea and should have been put out of its misery years ago.  Instead, the newest revision of the Higher Education Act has added to both its asset reporting requirements and the proportion of college theoretically financed by assets. Why is this such a bad idea?

• A single value for a business does not exist.  Take three different observers and they will come up with three different values for a given business.  While you can make an argument for publicly-traded companies having a single value based on their stock price, the vast majority of US businesses are privately held, often in illiquid markets with no recent available transaction information to guide valuation.  The question is nonsense.  Business owners in our client base express everything from outrage at the ignorance displayed by financial aid professionals in asking such an uninformed question to those who get past the emotion straightaway and work to report the lowest possible value.

• The very purpose of reporting the “value” of a business is questionable.  How exactly is the value of business relevant to need and financial aid awards?  We are guessing that the financial aid system assumes the business owners can leverage the business and use the proceeds of debt to pay for college.  There are so many things wrong with this idea that we will move to sub-bullet points:

  • Bank lending is not available to a significant number of service businesses without personal guarantees from the owner.

  • Banks don’t lend to a business just based on its net equity value.  Repayment is evaluated in terms of income, cash flow generation, what assets the business owns, how stable it is, the trustworthiness of the owners, etc.  Financial aid forms ask for one simple proxy to see how much can be borrowed for college, but that proxy is insufficient.

  • Businesses can’t willy-nilly borrow money for a non-corporate purpose.  When banks or financial services company use their capital to provide loans, they expect that loan to be invested in the business, not be used for the owner’s personal expenses.  The financial aid system almost seems to promote a sub rosa contravention of bank/business credit agreements.  Besides a business owner’s responsibilities in borrowing from a bank, the withdrawal of money from a business may trigger a tax, making it a particularly inefficient way to raise funds for college.

  • Many small businesses are co-owned by several people.  That means the corporation cannot be used as collateral for loans to individuals.  The financial aid questions try to get around this by only asking for the value of the portion of a business the family owns.  This is unrealistic.  While someone like Bill Gates can pledge a portion of the shares he owns in companies to a bank as collateral, a small business owner who is actively involved in running a business simply can’t do this because their ownership is not effective collateral.

  • Typically, profits from a small business flow through the owner’s personal tax filings and their Adjusted Gross Income (AGI). AGI is already assessed elsewhere, double counting the profits.

  • All of these comments apply to farms and their owners.

• Let’s move on to the CSS Profile’s questions about home equity.  What is the value of your home?  Expert real estate agents can usually provide a decent estimate of a price, although they will disagree on an exact number. We all know from experience how common surprises in house pricing are, with asking prices exceeded or not met in sales literally all of the time.  So what can serve as a source?  Zillow and Redfin are known to exaggerate prices to stimulate homeselling.  They are not reliable and should under no circumstances be used by families or colleges.  We genuinely don’t know the answer to this question although we’ve been recommending a “least bad” approach that often significantly reduces the home equity reported on the CSS.  (None of these comments about home equity applies to the FAFSA.)

  • Anecdote: One pair of parents calls up a real estate agent to value their home.  The agent, who is experienced, looks at Zillow’s online listing and thinks it is literally 25% too high.  She gives the parents her own price estimate, about $100k below the online value.  But that is undocumented and not the result of a home visit and inspection, so her estimate is unusable for financial aid purposes, just like the online value. How are parents to answer this question in the CSS?

  • These comments also apply to residential real estate investments.

• The CSS Profile asks for retirement accounts and balances (the FAFSA does not).  Why?  The schools using the CSS have their own proprietary formulas and use its data as raw inputs.  So how they use these retirement assets is unknown.

  • Retirement savings shouldn’t be plundered by colleges.  Let’s just state that as a principle.

  • If they access retirement savings, families take a double hit, because the distributions from the savings increase income and the Expected Family Contribution, accelerates taxes, and decreases need.  It is unfair; and again double counts an item.

  • Many retirement vehicles are not suitable sources of college funding.  While IRAs and 401k funds can be withdrawn for educational purposes, they are subject to penalties and accelerated taxation, making them a very inefficient source of financing.  Financial planners typically strongly recommend against dipping into retirement funds unless a real emergency occurs.  Why are colleges basing their need calculations on practices that are widely frowned upon by credentialed advisors?

  • Certain plans do not permit withdrawal of funds for educational purposes.  The federal employee Thrift Savings Plan, for example, does not permit such withdrawals in any circumstances.  And 403bs have different rules from 401ks covering withdrawals, with not all plans permitting them.  The CSS lumps all these different plan types together without differentiation, making the reported value useless in a needs assessment, even aside from the other problems listed here.

  • So far we have only been mentioning defined contribution plans.  There are plenty of defined benefit plans with beneficiaries out there, though the plans are declining in number.  These defined benefit assets – which are every bit as real as defined contribution assets – are not assessed in financial aid.  How is this fair?

• Ending with a broader objection, the financial aid system blatantly and clearly punishes people saving for retirement or some other purpose.  Take two families, each with $60,000.  One family uses the money to purchase a luxury vehicle; the other puts it in their savings.  The vehicle is not assessed; the savings are.  Consumption is rewarded; thrift is punished. 

The arbitrariness of the rules and the seeming lack of knowledge about tax rules and banking inherent in the questions undermines the credibility and the perceived honesty of financial aid offices, their employees and the system as a whole.  Pricing can’t be credibly determined by a broad, poorly defined, often nonsensical form that is then processed in an inscrutable way. Note the word “credibly.” Colleges can and do ask for whatever price they determine; that’s their right.  But the goodwill of the customers will be sacrificed if the process of arriving at this price is poorly-thought-out and transparently unfair. And any argument that colleges are rectifying economic inequities in the US by customized pricing based on these client disclosures fails if the calculation method isn’t credible.  While there’s no chance this will actually happen, the entire higher education system needs to ditch its asset tests forthwith.

Let’s end on a note of optimism. The FAFSA plays a very real roles in apportioning Pell and state higher education grants, as does the CSS Profile in setting prices at rich, selective, often need-blind colleges. But many other students increasingly operate in a world where the FAFSA and CSS exert only a marginal influence. The drivers behind this diminished importance: the growth of discounting at most private colleges; the fact that many public universities set their in-state cost of attendance at low enough a level where the typical middle-class student receives no need-based aid; and the use of market-based price discounting by public universities in recruiting out of state. That’s a lot of students who fall into these categories, and most of them are not much affected by the financial aid formulas. The asset questions in the FAFSA are also being de-emphasized in determining Pell eligibility because the income threshold for reporting assets is now set high enough to allow most Pell funds to be assigned without any asset reporting.

All this is a good thing. Despite such progress, it’s worth picking apart the specious nature of asset assessments in financial aid awards. If income assessments are probably a bad idea - we can leave that debate for another time - using assets is definitely one.

CTAS supports families and the educational professionals counseling these families with integrated college financial aid, pricing, funding and financial planning advice to help them shape their futures with direction and agency.