College Planners: Avoid These Common Financial Aid Mistakes

College acceptance letters are already in the mail, but for those who haven't completed their Federal Financial Aid Forms, there is still time--and yes, you should fill them out.

We recently checked in with Mark Kantrowitz, publisher of Edvisors.com, a college-planning website, about the common mistakes college planners make when filling out the FAFSA.

Mark, one of the most common mistakes people make when it comes to the FAFSA is failing to fill it out at all. Why is that?
It's leaving money on the table. Everybody who files a FAFSA is eligible for the unsubsidized Federal Stafford Loan and the Parent PLUS Loan. They don't depend on financial need. About 2.3 million undergraduate students didn't file the FAFSA who would have been eligible for a Pell Grant, and of them, about 1.1 million would have been eligible for a full Pell Grant.

The FAFSA is also your gateway not just to federal student aid, but also to financial aid from the state governments as well as financial aid from all but about 250 mostly private colleges.

Would you recommend that even students from higher-income families, who maybe don't expect to receive any aid, still fill out the FAFSA?
Absolutely. Financial aid is based on financial need, which is the difference between the cost of attendance and the expected family contribution. You can have greater financial need if you have a lower EFC [expected family contribution, a financial-aid calculation that measures your family's financial strength]. But you can also have greater financial need if you're enrolled at a higher-cost college. Middle- and upper-income students are more likely to enroll at much more expensive colleges, and they may qualify for some need-based aid at those more expensive schools.

We are now in mid-March; the tax deadline is coming up next month. Is it too late to file for financial aid if you have already been accepted to a school or if you are planning to attend in the fall?
Ideally, you should file as soon as possible after Jan. 1. The federal government has an 18-month application cycle. You can apply for Federal Student Aid as late as the last day of the semester of the academic year or June 30 of 2015, whichever comes first.

However the state aid and the institutional aid tend to have much earlier deadlines. So you may have missed the deadlines for your state. There are two states that have deadlines in February. There are 10 states that have deadlines in March. There are seven states that award their aid on a first-come, first-served basis. But it's better to apply than to not apply. There still is some money available, and you should get a head start on next year's FAFSA by making sure to put in your calendar to start as soon as possible after Jan. 1.

Family income can be tricky. Can you explain some common mistakes related to that?
Family income is based off of the adjusted gross income, because it is a verifiable figure; it's from your prior tax year. They then add in certain types of untaxed income. Say you had money deducted from your paycheck before taxes to contribute to a 401(k) or other retirement plan.Since that's a discretionary choice, they add that back into adjusted gross income to yield total income, and they base your aid eligibility on that figure.

So you need to be careful with regard to the prior tax year's income to make sure you don't artificially inflate that income. The formula is very heavily weighted toward income. If you have unusual capital gains that aren't offset by losses or [offset by a loss in salary], that can cause you to have higher income than you otherwise would, which will affect your aid eligibility.

You may want to take a hardship distribution from your retirement plan to help pay for college costs. Or you may want to sell stocks to pay for college costs. But if this occurs in the year before the child enrolls in college, it can reduce their eligibility for need-based aid. So you have to be very careful about the income in the year before you enroll in college and each subsequent year while you're in college.

What are some other common mistakes people make when filling out the FAFSA?
One is with regard to retirement-plan accounts. Qualified retirement plans are not treated as an asset on the Free Application for Federal Student Aid. But families sometimes include it in the investments figure. So you need to be careful because if you count it, it's going to hurt your aid eligibility.

Another issue is saving for college in the child's name as opposed to the parent's name. If the money is in a 529 college-savings plan account, a prepaid tuition account, or a Coverdell Education Savings Account, it's going to be treated as though it were a parent asset. But if it's in a UGMA or UTMA custodial bank or brokerage account, it's going to be treated as a child asset, and those assets are assessed much more heavily than money in the parent's name.

With the child's assets, a flat 20% of the asset value reduces aid eligibility; whereas, with parent assets, part of the assets are sheltered. Typically $30,000-$50,000 of parent assets, depending on the age of the parent, are going to be sheltered from the need-analysis formula. And then there's a bracketed system for any reportable assets beyond that point, which maxes out at 5.64%. So $10,000 in the parent's name is going to reduce aid eligibility by at most $564, whereas $10,000 in the child's name will reduce aid eligibility by $2,000.

After I fill out the FAFSA, what other steps do I need to take?
You need to review the student aid report when you get it back. You are going to get financial aid award letters shortly after the admissions letters from the schools, and you need to take a careful look at them. It can be very hard to interpret what the college is really going to cost you. You need to figure out what the grant is and make sure that they are listing all of the actual costs--not just the direct costs like tuition fees, but also room and board, books and supplies, transportation, miscellaneous personal expenses, and cost of a computer.

Then you subtract the grants--the gift aid, the money that doesn't need to be repaid from the cost of attendance. That gets you the net price, and you can compare the net price among the different colleges to see which is going to be more affordable, and whether it is worthwhile to go to a more expensive school that is a better fit in other ways. This allows you to make a more informed choice about the trade-offs between affordability and the quality of the institution.

You have to, however, be very careful within that price, because about half of all colleges practice frontloading of grants, where grants during your first year are going to be more generous than your grants in subsequent years. That yields a lower net price your first year than as an upperclassman. It's almost like a bait and switch.

Then if you've won a lot of private scholarships, you have to know what that college's outside scholarship policy is. When you receive need-based aid and then get a merit-based, non-need-based scholarship, it reduces your financial need, so the college has to reduce the need-based financial-aid package. They have flexibility, however, in how they reduce that aid package. They could reduce your grants, in which case you have no net financial gain and your net price remains unchanged. Or they could reduce the loans, in which case, your net price goes down because you are substituting a grant for a loan.