Last month's column discussed the importance of helping clients maximize the amount of money available to pay for higher education expenses — specifically, by encouraging parents to apply for financial aid.

But it's what you tell them to do with their earnings and assets before and during their children's college years that is most important: It can have a huge effect on the amount and type of aid the family receives. Here's how to make sure your recommendations don't inadvertently end up costing your clients thousands of dollars in need-based financial assistance.

A Caveat Or Three

Before you hurtle yourself and your clients into the financial aid frenzy, there are a few things to keep in mind. First, you shouldn't let financial aid-boosting strategies take priority over more important investment, tax, and financial planning issues and goals.

Second, although some of the increased aid might come in the form of grants, a good portion will be subsidized loans or work-study programs. The family may decide to forgo that tepid help, and tap income or assets instead.

Finally, and as always, honesty is the best policy. A person convicted of lying on a financial aid form can be subject to fines and/or a prison term (and no, being broke and in jail aren't likely to garner the parents any extra aid).

IM Or FM?

There are two basic formulas that schools use to calculate the “expected family contribution” (EFC), which, when subtracted from the total cost of attending the school in question, leaves the amount that could potentially be offset by financial aid.

The Federal Methodology (FM) is used to award federal and state financial aid, such as Pell grants, Stafford loans and PLUS loans. Additionally, roughly 600 (mostly private) schools use the Institutional Methodology (IM). Some schools may also have their own specific forms and formulas.

It's a good idea for your clients to find out the method used by the schools their children are targeting, as the resulting numbers can vary widely. For example, the IM may encompass more assets or a longer time frame than the FM.

Here are the different potential sources of a family's income and assets, and the portion of each source that could be included in the EFC.

Parent Income (0 To 47 percent)

Although it might be difficult for working parents to manipulate their salary to minimize the EFC, they should at least try to arrange any bonuses to be paid in years before or after the base years.

As to your financial planning moves — if the parents are selling any assets on which they have larger capital gains, try to get the sale completed before or after the “base year” of the financial aid process (the year before they'll need any money).

Clients nearing their Golden Years might be disappointed to find out that contributions made to retirement plans (like an IRA or 401k) in any base year are added back into the EFC.

So, at least from a financial aid standpoint, it's better for them to maximize retirement savings before their children go to college, and then plan on redirecting the otherwise deferred amounts toward paying college costs.

Parents who are already retired when their children go off to college may be able to minimize pension payments and retirement plan withdrawals so that this portion of the EFC is as small as possible.

Whether it's by design or circumstance, clients in the lower income brackets may get special treatment by the FM. If the parents meet certain criteria and have income of less than $50,000, the family can qualify for the “simplified EFC,” where assets are not considered in the formula.

Those who meet the same criteria with less than $20,000 in adjusted gross income can qualify for a big fat “zero” for their EFC (and as well they should!).

Parent Assets(0 To 5.6 percent)

Savings and investments held in the parents' names get much more favorable treatment, with an initial amount based on the age of the older parent that is completely free from inclusion.

Less than 6 percent of the rest of their money will be included in the EFC, and assets in retirement plans may not be counted at all.

Clients who have substantial investments held outside of retirement accounts may want to place a portion into an annuity, which, at least under the FM, is considered a “retirement” plan and not counted in the EFC.

Of course, there are other factors to consider in this maneuver, such as the costs, benefits and drawbacks of annuities, as well as any capital gains that might be realized when liquidating assets to fund the annuity.

Families who are desperate enough to consider tapping IRAs or 401ks to help pay for college costs should think twice, as the withdrawals will count as “income” for both tax and financial aid purposes.

Instead, they should take out a loan against their at-work retirement plans, if possible. Or, if they only have IRAs, borrow enough from traditional sources of education loans to cover current college expenses, and then repay the loan with IRA withdrawals after the child graduates.

Clients who have both liquid assets and consumer debt should consider paying the debt down or off, as they will remove the assets from the EFC, and save money on interest as well.

This is especially true under the FM, as home equity is not considered in the formula. So paying down a mortgage will reduce the available assets without decreasing the family's net worth.

That said, before parents begin shifting assets around to get a more favorable EFC, they should make sure that they can still get at the money with relatively little friction if the financial aid awarded comes up short.

Student Income (0 To 50 percent)

For the 2009-2010 school year FM, typically the first $3,750 of a student's earned income will be sheltered from inclusion in the EFC. After that, up to half of the earnings will be taken before any aid is awarded.

Between the kid's likely-low wages, and the damage the earnings will do to any aid awards, it's probably better if he only works enough to earn a few thousand dollars each year, and spends the rest of the time studying or taking a larger class load.

Student Assets (up To 25 percent)

Money held in the student's name (like in an UTMA/UGMA account) may offer the family a benefit at tax time, as interest and capital gains earned in the account may be taxed at a lower rate than that of the parents.

But for that advantage, families may incur at least two drawbacks: The first, of course, is that the account is technically owned by the child, who may choose to cash it out and spend it as she pleases, instead of on something that pleases her parents.

More germane to financial aid planning is that up to 20 percent of the assets in the student's name will be added to the EFC each year under the FM, and up to 25 percent under the IM process.

Hopefully, your clients have avoided saving money in their children's names. But there are some solutions for those who have already made this mistake.

Families can try to spend down these accounts for purposes that benefit the child, such as braces, a car, or private elementary or secondary school tuition. They can then deposit money that would have otherwise paid for these expenses into more advantageous investment vehicles.

Another little-known technique is to place the money into a student-owned 529 college savings plan. The family will shelter future gains, income, and qualified withdrawals from taxation.

And they may get much more aid under the FM, as UTMA 529s owned by a dependent student will be counted as a parental asset, with no more than 5.6 percent going toward the EFC (the IM may still count an UTMA 529 as a student asset).

If neither of these solutions applies, then families should at least tap the students' assets for the first education expenses, and only use other family money or loans when the kid's money runs out.

More Help

Parents with children nearing college age should visit fafsa.ed.gov to learn more about the federal financial application and award process. If they have a senior in high school now, they should file their FAFSA as soon after January 1, 2009 as they can.

For those with a few more years to plan, you and they can take a test drive through the financial aid process via the helpful site finaid.org. The site offers several calculators that can provide an idea of what your clients' EFC might be, and what tweaks might improve the amount of financial aid received.

Writer' BIO:

Kevin McKinley
CFP© is Principal/Owner of McKinley Money LLC, an independent registered investment advisor. He is also the author of the book Make Your Kid a Millionaire (Simon & Schuster), and provides speaking and consulting services on family financial planning topics. Find out more at www.advisortipsheet.com