Nuts and Bolts of Need Analysis

A webinar sponsored by the North Carolina Association of Student Financial Aid Administrators and the NC State Education Assistance Authority

Presented by Steve Brooks, Executive Director, North Carolina State Education Assistance Authority,October 2009

Need Analysis and Professional Judgment

• First in a series of webinars on need analysis nuts and bolts

• Focus today is on principles of need analysis and why they are vital to making good professional judgment decisions

• We will discuss federal methodology and its rules yet also consider the broader context of meeting needs fairly, both complying with FM rules and ALSO appropriately allocating discretionary campus dollars

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Need Analysis and Professional Judgment

• Some significant themes of this series:– Decision of whether to do a professional judgment is

dependent on understanding both need analysis and federal eligibility determination

– How you make a professional judgment matters – FM limitations – change data elements only– “Ripple effects” by changing the “wrong” data element– Understand origin and derivation of methodology

tables to ensure equitable results

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College CostsWho Benefits? Who Pays?

• No one pays full costs of education• State and private donors subsidize heavily• Of the costs that are left, who should pay?

• Society benefits – so it subsidizes for all AND provides aid for those who cannot pay net costs

• Student benefits – so student and family must have an obligation to pay if they can

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Need Analysis Principles• First principle of need based financial aid:

– Parents and students have primary responsibility for financing and

– To the extent that they are able to pay, they should pay the costs of college education

• So we have to have a system to measure the extent to which they are able to pay

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We all Need Analysis!

-- Sigmund Freud

A system of “need analysis”• Three ways to pay for college

– Saving in advance– Using current income– Borrowing and paying with future income

• Our system looks one year at a time - a snapshot – and uses that to imagine a video over time

• That is, we look at current data and extrapolate the family’s ability to pay college costs

• An art as well as a science

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The artist’s tools• Income and assets used to measure financial

strength– Families with assets have financing options– Families with assets experience less pressure on

current-year income • Some argue this penalizes families for saving• But in fact assets play only a small part, and

those who did not save almost always have to do more borrowing in the end

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EFC as Measure of Family’s Responsibility (Share)

• The result of our analysis is the “expected family contribution,” or EFC

• We use that, along with reasonable costs of attendance, to calculate the student’s demonstrated need for aid

• Concepts that must be a part of any measure• Relative sacrifice• Face validity

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As the competition for enrollment and talent gets tighter, as it will, we may undercut the old-fashioned idea that [financial aid] is intended to help the needy and deserving scholar, and that well-off families should help themselves. We will do ourselves and the country no good if we diminish the force of this fine old idea.

May 19531953 John H. Monro

How did all of this begin?

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A brief history lesson• 1954- CSS founded to support awarding of need-

based aid • 1965- Higher Education Act

– Federal legislative umbrella; Title IV Programs– Federal aid was distributed according to the formula

developed by financial aid professionals• 1972- HEA started “federalization”

– Basic Educational Opportunity Grant (now Pell Grant)– Introduced separate federal application and eligibility

formula (for BEOG only; other aid still up to aid community)

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Where We’ve Been . . . • 1974- Keppel Task Force

– The situation• Federal, state & institutional forms• Need analysis & Federal eligibility• No community standards

– The recommendations• Common application - “multiple data entry”• Uniform Methodology (UM) same result despite which

form might be used• BEOG still had a separate eligibility formula to ration

funds• Community standards - National Coalition of aid

community to develop and maintain the UM

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Where We’ve Been . . .

• 1978- Multiple data entry began• 1986- HEA “federalization”

– Congressional Methodology (CM)• CM replaced UM in 1988-99• No longer a community standard; now took Act of

Congress to change methodology– Continued Pell Grant formula as a separate eligibility

calculation (BEOG renamed Pell Grant in 1980)

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To The Present…

• 1992- HEA consolidated CM and Pell– Federal Methodology (FM) – Federal application only– Merger of formulas for Pell Grant and CM into

FM presented some interesting political (not philosophical) outcomes

– Professional judgment authority explicitly given to aid administrators

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What is “Financial Need?”

Total College Costs- Family Contribution= Need/Aid Eligibility

This is the one aspect that has remained constant since 1954

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Need Analysis Principles• Some principles remain…… but they are often lost in the rush to comply

with ever-changing federal rules

• Question is how to make the system FAIR

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Need Analysis Principles–Horizontal equity – lining them up

in order of discretionary income

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Need Analysis Principles

• Vertical equity – assessing ability to pay in a progressive manner

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So, What ISProfessional Judgment?

I exercise professional judgment,

therefore I am! -- Descartes

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Professional Judgment

• Need analysis is a guide for judgment, not a substitute– Step Back – “is this the right answer?”– Easy to “hide behind the rules”

• Aid Administrator is final authority• Effective PJ impossible without understanding the

“why’s” of need analysis• Good professional judgment includes

understanding FM rules AND understanding need analysis principles and practices

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Federal Methodology (FM)

• Established by the Higher Education Amendments of 1992 (1993-94)

• Hybrid of CM and Pell formulas• Official U.S.E.D. calculation required

– Student must complete FAFSA– CSS estimates FM results on PROFILE– INAS FM results match ED results

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Federal Methodology • Distribution formula--not traditional need

analysis• Developed by U.S. Congress

– the result of merging UM and Pell Grant – subject to politics/budgetary limits – no commitment to keeping formula economically-

sound – politics, not economics• Good professional judgment includes

understanding FM rules AND understanding need analysis principles and practices

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Federal Methodology

Used to determine eligibility for:• All Title IV student aid programs• Some state grant programs *• Some private scholarships• Some institutional aid*All our North Carolina programs use FAFSA data but not all use the federal methodology – a crucial

distinction to understand in doing professional judgment

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Whose income & asset information is required in FMand whose is excluded but may deserve consideration when doing professional judgment ?

• Custodial parent(s) – always used in FM unless professional judgment to make student independent

• Stepparents – normally used in FM but might be excluded in professional judgment under some circumstances

• Non-custodial parent(s) – never used in FM, but might be factor in deciding if a professional judgment is appropriate

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What is income?

• Income subject to taxation– Wages, salaries and tips– Net income from business/rental/farm– Interest and dividends– Capital gains/losses????

• Income not subject to taxation– Interest on tax free bonds– Tax deferred payments (401K, for example)– Other

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What income counts in FM? Some Taxable income

• Adjusted gross income (exclude combat pay)• Income earned from work

+ Some Untaxed income- Excluded Income============================ Total income used in FM

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Should be aware of other income as well before professional judgment

FM untaxed income includes• Payments to tax-deferred pension & savings plans • IRA deductions & payments to a SEP/KEOGH/similar plans• Child support received• Tax exempt interest• Untaxed portion of IRA distributions (not rollovers) • Untaxed portions of pensions• Housing, food and other living allowances paid to military,

clergy, and others• Veterans non-education benefits• VA Work Study Allowances• Other untaxed income not reported elsewhere• Money received or paid on your behalf

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No Longer Untaxed Income for FM• Earned Income Credit• Welfare benefits including TANF• Credit for federal tax on special fuels • Foreign income exclusion• Untaxed Social Security benefits (SSI)• Additional Child Tax Credits (IRS 1040 Line 66) • Combat Pay not included in AGI • Earnings from work under a cooperative education program

not counted in AGI

Should any of these be considered before professional judgment decision is made?

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Discretionary Income

• The goal of need analysis is to count all legitimate income, and to exclude income that is not representative of real situation (using snapshot to see a video)

• Horizontal equity – get them all to the right place in line and know that each is in order of discretionary income

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Discretionary income is total income minus certain allowances

Idea is that there is some income that is not available for any discretionary use

• Taxes Paid: – Federal Income Tax; State and Local estimated taxes; FICA taxes

• Employment Expense Allowance• Income Protection Allowance

– NOT a “living expense allowance” (“how can we live on that?”)– Represents an amount below which a family has absolutely

no discretion as to how to spend a dollar and above which SOME discretion begins

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Horizontal and Vertical Equity

• Now we have all families lined up in order of amount of discretionary income (horizontal equity)

• We next have to determine what portion of that discretionary income should go to college education – Vertical equity (progressive assessment) versus flat tax – the more discretionary dollars a family has, the greater portion

of those dollars it can afford to use for a given purpose– So system assesses from 22% up to 47% depending on

amount of discretionary income

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The role of assets in measuring ability to pay

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What assets count and don’t count in FM?

Do count: Cash, Savings & Checking

Net Worth of InvestmentsNet Worth of Some Business/Farm

529 college savings assetsDon’t count:

Home equity Some business and farm assets Retirement and life insurance

Should be aware of actual total net worth before doing professional judgment! You can - but do not have to - do a PJ!

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(Education Savings and) Asset Protection Allowance

• Derivation – for retirementMoney required to purchase an annuity today that, at retirement

age, would provide a moderate standard of living when combined with social security

• Unclear purpose today

We don’t assess retirement assets – a disconnected table with no real economic rationale (but a political rationale for sure!)

• Be aware before doing professional judgment

Generous protection is built into the FM formula and must be taken into consideration

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Contribution from Assets

Total Net Worth (of countable assets)

- Education Savings & Asset Protection Allowance

= Discretionary Net Worth

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Contribution from Assets• Discretionary Net Worth• Multiplied by Asset Conversion Rate – 12%, and

added to available income• Assessed at 22% to 47%

– Thus 5.6% net is maximum from parental assets (that is, 47% * 12% = 5.64%)

– Putative Income from assets is one way to look at it – a tie breaker in the formula

– Two families, identical incomes, different assets – which has more long term capacity to pay?

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In conclusion

• Hope this has been a good introductory discussion of need analysis principles and theory and how they interact with FM

• Next steps – future webinars this fall:1. Income items and professional judgment2. Asset items and professional judgment3. Extraordinary expenses and professional judgment

• Case studies and discussion, even hand calculations!

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Questions and Comments

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