The asset protection allowance shelters a portion of assets reported on the Free Application for Federal Student Aid (FAFSA). But, the amount of assets sheltered by the asset protection allowance has been decreasing over the last decade, and will soon disappear completely. Congress has not yet taken action to address the problem.
The asset protection allowance, which is identified in the Higher Education Act of 1965 as the Education Savings and Asset Protection Allowance, is based on the age of the older parent. The asset protection allowance is highest for parents who are age 65 and older.
In 2009-10, the asset protection allowance peaked at $84,000 for parents age 65 and older. Since then, the asset protection allowance has decreased by about $6,000 a year, reaching a low of $9,400 in 2020-21. That’s the equivalent of about a $4,200 drop in eligibility for need-based financial aid.
The maximum asset protection allowance increased slightly to $10,500 in 2021-22, but that is just a temporary and inadequate reprieve. Similar small increases occurred in 2017-18 and 2018-19, but were followed by a 44% decrease in 2019-20 and a 50% decrease in 2020-21.
Why is the Asset Protection Allowance Disappearing?
The asset protection allowance is based on “the present value cost, rounded to the nearest $100, of an annuity that would provide, for each age cohort of 40 and above, a supplemental income at age 65 (adjusted for inflation) equal to the difference between the moderate family income (as most recently determined by the Bureau of Labor Statistics), and the current average social security retirement benefits.” [20 USC 1087rr(d)]
This definition of the asset protection allowance was never realistic, because it assumes a 6% inflation rate, an 8% return on investment for the annuity and a 6% sales commission.
However, the most important flaw in the definition of the asset protection allowance is that the moderate family income has remained more or less unchanged even as the average Social Security retirement benefit has increased. As this gap narrows, the asset protection allowance decreases.
How Does the Asset Protection Allowance Affect Families?
The decrease in the asset protection allowance mostly affects moderate- and middle-income families. Most low-income families, with parent income under $50,000, will have all assets disregarded by the Simplified Needs Test.
The decrease in the asset protection allowance has been more pronounced for single parents than for two-parent households. The maximum asset protection allowance for single parents was just $3,900 in 2021-22, nearly two-thirds lower than the $10,500 asset protection allowance for two-parent households. Single parents have greater difficulty saving for college, with just one income.
Younger parents also have a lower asset protection allowance. The asset protection allowance for parents age 48, the median age for parents of college-age children, is more than a third lower for parents age 65 and older. The asset protection allowance for parents age 48 was just $6,600 in 2021-22. Parents who are age 40 have half the asset protection allowance of older parents. But, all parents have to save for the same college costs.
Families are not aware of the decline in the asset protection allowance. They are unaware of the details of how the financial aid formula works. Changes in the expected family contribution (EFC) due to the decrease in the asset protection allowance are not itemized. The changes in the EFC are also gradual. The magnitude of the increase in the EFC, about $350 a year on average, is also partially offset by normal inflationary adjustments in the rest of the financial aid formula.
How to Fix the Asset Protection Allowance
The best solution is to eliminate the asset protection allowance and instead exclude all college savings plans (529 plans, prepaid tuition plans, and Coverdell education savings accounts) from reportable assets on the FAFSA. In addition, qualified distributions from college savings plans should be excluded from income on the FAFSA.
Such a change will encourage families to save for college by eliminating the penalty for college savings.
An even better solution would be to eliminate all assets from the FAFSA. The FAFSA doesn’t consider debts as offsetting assets, unless the debt is secured by a reportable asset. Credit card debt and auto loans are ignored, so the FAFSA does not really reflect the family’s financial strength. Assets tend to correlate well with income, so the financial aid formula does not really need to consider assets. If necessary, the contribution from income can be adjusted to compensate for the elimination of the contribution from assets.
A more limited alternative would be to shelter a fixed dollar amount per child, such as $50,000 per child, and adjust this amount annually for inflation.
Mark Kantrowitz is publisher and VP of research for Savingforcollege.com, a popular guide to saving and paying for college.