Archived Information

Reauthorization of the Higher Education Act

Encourage Savings, Increase Fairness, and Simplify the Financial Aid Process for Students and Families by Changing the Student Aid Eligibility Formula

The current federal student financial aid formula can unfairly penalize families who are responsible and save for college, and unnecessarily burdens students and families. The Clinton Administration is requesting authority to change the way the Higher Education Act treats a family?s assets to address these problems and promote savings, fairness, and simplicity.

Current Law Needs to Be Changed: Federal law now bases a family?s financial aid determination on their assets as well as their income. Assets are also used by many colleges and universities in determining institutional aid. However, current law (as reauthorized in 1992) exempts certain assets, such as homes and savings in certain retirement plans. As a result, current law:

• Penalizes Families Who Save for College. If one family sacrifices and saves for their children?s education and another family -- with an identical salary history -- spends its savings on expensive clothing and entertainment, the second family may be eligible for more aid than the first, responsible family.

  According to recent economic analysis, a typical family that chooses to save $50,000 in assets rather than consuming the resources, loses between $10,000 and $15,000 in financial aid. [Andrew W. Dick, Aaron S. Edlin, "The Implicit Taxes from College Financial Aid," Journal of Public Economics 65, 1997.]

  Economic research has also shown that families with near college-aged children save 16 to 27% less than other families, due to savings disincentives created by the financial aid formula. [Taejong Kim, Working Paper "Implicit Taxes in College Financial Aid and Family Savings" York University, 11/96, estimates based on pre-92 formula that did not exclude housing equity.]

• Requires Families to Provide Extensive Information About Their Assets. Nearly 40% of the financial questions on the free application for federal student aid (14 of 38) ask about family assets and savings. Eliminating asset reporting would simplify the application process and relieve students and families of a significant burden by eliminating nearly 40% of the financial questions.

• Penalizes Honest Families. Studies have shown that up to one-fifth of parents incorrectly report their liquid assets -- money in cash, checking and savings accounts -- on student aid applications. [US Department of Education, Title IV Quality Control Project, 6/87.] Families who do not report all of their assets may be eligible for more aid than those that report their assets honestly and accurately.

• Hurts Families Who Rent. Families who rent their homes can be penalized because homeowners can exclude the value of their homes from their assets, thereby qualifying for more aid than renters with the same salary history and income.

• Disadvantages Families Whose Employers Do Not Offer Retirement Plans. Families who do not have access to 401(k) or other forms of retirement or pension plans can be penalized because these assets are also ignored in the student aid eligibility formula.

Reform Would Increase Fairness, Encourage Savings, and Simplify the Aid Application: The Clinton Administration?s proposal for the reauthorization of the Higher Education Act addresses the inequities and complexity described above. It would provide authority to change the current treatment of assets, after consultation with the higher education community. For example, it would enable the Secretary of Education to estimate a family?s assets based on family income, parent age and other factors or to exempt assets entirely. Any of these approaches would be designed to protect families with incomes so low they cannot save.

• Creates Large New Savings Incentive for Families. Estimating or dropping assets from the financial aid formula would establish a strong incentive for increased saving. Conservative economists Martin and Kathleen Feldstein reported, "The current rule substantially reduces saving among families [with near college-aged children]. The proposed reform would no longer deter families from saving, since they would no longer fear losing a large part of those savings in the form of reduced financial aid." [Feldstein, "A fairer way to pay for college," Boston Globe, 9/16/97.]

• Causes No Net Change in Distribution of Financial Aid. Recent analysis by the Treasury Department shows that -- across the income distribution -- families would receive roughly the same financial aid as they receive under current law as a result of estimating or dropping assets from the formula used to determine financial need.
  For example, Treasury found that if assets are estimated, no students in the bottom 40% of the income distribution would lose aid as a result of the change from current law, and the vast majority of families in the bottom 60% (98 of every 100 families) would receive the same or more aid than they currently receive. As under current law, students? financial aid awards could be adjusted by their aid administrators to reflect individual circumstances.

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