Insurance Purchases Don’t Increase Financial Aid

Run from Planners Pushing These Schemes

I was at a pharmaceutical networking event a few months ago discussing college financial planning with pharmaceutical executive. She was boasting to me that she had just “invested” in an insurance policy recommend by her “advisor,” and as a result, her son was going to qualify for thousands of dollars in needs-based financial aid. Really? This situation was extremely uncomfortable, because my options were to tell her she likely made a huge mistake or to smile and say nothing at all. First, let me give you a little context.

Needs-Based Financial Aid Primer

Financial aid is awarded by colleges primarily for academic achievement (merit aid) and for financial need (needs-based aid). My friend was trying to increase the latter. To get needs-based aid, families need to fill out the FAFSA (Free Application for Federal Student Aid) form, and the output from the FAFSA is the Expected Family Contribution (EFC). The EFC is the starting point for what the family is expected to contribute for college, but the actual amount is almost always higher. So if you want to maximize your needs-based aid, you will want to minimize your EFC.

Here’s how a needs-based award is calculated: If the total cost of attendance at a particular college is $45,000 and your EFC is $20,000, then you have $25,000 of financial need. A college will typically meet only a portion (40% – 70%) of that need with a combination of grants, loans, and work study. So for every dollar you lower your EFC, you get only a fraction of that back in financial aid, and most or all of it could be in the form of loans and work study. In this example, a college that meets 60% of need would provide $15,000 of “aid” in the form of grants, loans, and work study. The family’s bill for college will be (at a minimum) the $20,000 EFC plus the “unmet” need of $10,000 ($25,000 – $15,000).

How Buying Insurance Lowers EFC

The EFC calculation is very complex, but it includes 5.64% of the parent’s assets plus 22%-47% of the parent’s income. (A portion of the student’s income and assets is also included, but that is not relevant to this discussion.) Assets such as cash, stocks, bonds, mutual funds and other investments (including 529 assets) are assessed at 5.64%, while 401(k)s, IRAs, and retirement assets are not assessed. Cash value life insurance and annuities are also not included, and here is where the insurance salespeople make their pitch.

For every $100,000 my pharma friend moved into the insurance product, her EFC would drop by $5,640 and she would have additional financial need in the same amount. But here is what she missed:

The insurance agent failed to take into account the executive’s salary, which approached $200,000 per year. According to Edvisors.com, EFC is increased by approximately 30% of the executive’s income over her $26,000 income protection allowance. Therefore, her $200,000 salary alone would trigger an EFC of over $50,000.
The insurance salesman has no idea how much of my friend’s financial need would be met by the colleges the family was considering, or if the need would be met through loans or grants.
Since she sold investments at a gain to buy the insurance, her EFC would rise even higher by 30% of the taxable gain.
The cost of attendance still must exceed the EFC for the family to have financial need. If her EFC dropped from (say) $90,000 to $84,360, she still would not have any financial need because the cost of attendance at college does not (yet) exceed $84,360!

Very intelligent professionals can make very big financial mistakes if they don’t have all the facts. Get financial advice from a professional who is a fiduciary and who legally must put your interests ahead of their own. Needless to say, insurance agents don’t have a fiduciary duty to their customers.

Should I have told my pharma friend she made a mistake in this social situation? Doing so would not have remedied her situation, so I held my tongue. However, by sharing this story, I hope that I can prevent others from making a similar expensive mistake.