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Why not to cheat in asking for financial aid

(MoneyWatch) Is it OK to cheat on the Free Application for Financial Aid?

That's essentially what a mom asked me recently. She's worried that her ex-husband seems to be advocating that the family cheat on the FAFSA to qualify for more financial aid. Read her email and then find out the advice that I gave her.

Hi Lynn,

I'm divorced, now remarried. My ex is single and plans to fill out the FASFA when he completes his taxes (hopefully, this week). We have 529 plansfor both kids, now 18 and 16. Together they are worth about $80,000.

My ex seems to think that we need to "play" around with these accounts, perhaps transferring ownership to his parents or putting the entire "stash" into our younger child's 529 accounts or doing some kind of fancy back-and-forth moving of the money to keep it off the FASFA radar.

This makes me nervous. I've read that transferring ownership to a third party only makes it worse for my son, as it will be counted as untaxed income next year. He claims he's an expert since he has an MBA in finance and has talked with experts, and I should respect his decisions. However, I want to do everything I can to protect my children's 529 assets. Sure, I do want to ensure they get the most financial aid possible, but not by taking any risks. 

Any advice would be VERY much appreciated!!! Thank you in advance.

Count income, not assets

Wow. A guy gets an MBA and he thinks he knows a foolproof way to cheat on the FAFSA. 

Depending on what your ex-husband proposes doing, he could be breaking the law. Besides, there is no reason to do it. People frequently believe that their education savings accounts will sabotage their chances for financial aid, but that's rarely the  case.

Financial aid formulas are heavily dependent upon a family's income not assets. So the major factor will be the income of your ex-husband and, if he remarried, his spouse. Chances are the 529 assets wouldn't make much, if any, impact on a financial aid award and he would be risking the wrath of the federal government if he hid them.

Assets don't usually affect financial aid because the federal government allows parents to shield a certain amount of their non-retirement money from aid calculations. (Retirement assets aren't counted at all in aid formulas.)

How much money you can shield depends on the age of the oldest parent. A 50-year parent, for instance, could shield $40,900 from aid calculations. While $80,000 sounds like a lot, it would only potential increase aid by $2,200. (For more information, see my post, "A common myth about college financial aid.")

As a practical matter, it's been estimated that only seven percent of families have enough non-retirement assets to reduce their financial aid chances.

If your ex-husband moved money to another family member's 529 account, it would still have to be declared on the FAFSA.

Don't do the crime

Here are three other reasons why your ex-husband should play it straight and report all assets on the FAFSA:

1. Providing false information on the FAFSA is a crime. You can be fined up to $20,000 and/or face up to five years in prison. Cheaters face the penalty whether or not their deception resulted in receiving federal student aid or not.

2. You will forfeit your aid. If you are discovered cheating, your child would have to return all the financial aid.

3. Hiding assets creates a paper trail. If a parent hopes to hide money in a mattress, they have to first sell investments, which triggers paperwork and the reporting of any capital gains to the IRS.