The Investment Scientist

Little-known Secrets of How Small Business Owners Pay for their Kids’ Education

Posted on: July 18, 2012

College graduation

Being a small business owner comes with risk, responsibilities, and advantages.

This week I went to a seminar called “Little-known Secrets of Paying for College”.

My biggest take away was that everything being equal, being a small business owner makes it easier for your kids to qualify for financial aid. Let me explain.

Universities and colleges determine the financial aid eligibility of a student by the following formula: COA – EFC, where COA stands for cost of attendance and EFC stands for expected family contribution. COA is fixed, so the lower the EFC, the higher the amount of aid the student is eligible for.

EFC itself is determined by four factors: parents’ income and assets, and student’s income and assets.

As a general rule of thumb, the lower the income and assets of the parents and the student, the lower the EFC.

What gives rise to opportunities is that some assets are considered nonassessable, therefore, not counted in the calculation. The following are nonassessable assets:

  1. Retirement plan assets
  2. Home equity
  3. A business with fewer than 100 employees
  4. Life insurance and annuities
  5. Household items

If you are a business owner, here are a few things you can do to help your kids get financial aid:

  1. Create a generous deferred compensation retirement plan well before your kids go to college. This has the dual benefit of making your assets nonassessable as well as reducing your current income. Both lead to reduction in EFC
  2. Keep your family wealth in the business as much as possible, since business assets of employers with fewer than 100 employees are not counted in EFC calculation. If you have $500k available for distribution from your business, distribute it after your kids have gone to college instead of before.

If you are not a business owner, you don’t design your own retirement plan, and you don’t have business assets, your options are somewhat limited. Still, you can pay off your mortgage instead of keeping money in your bank and brokerage accounts, since your bank and brokerage accounts are assessable and your home equity is not.

After that, if you still have so many assessable assets that it hurts your kids’ eligibility for financial aid (but not enough to pay for their college,) you should start a business.

Get my white paper: The Informed Investor: 5 Key Concepts for Financial Success.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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