We are parents of a high school junior looking to learn about the best
places to put our money for when we fill out that first FAFSA in two years.
My husband insists that we have a "safety net" of at least $10,000 in
an account for emergencies (like large car maintenance costs, accident
deductibles, etc.). Currently that money is in our money market
account, where we also set aside money for our annual property taxes.
From all I read, though, it needs to be in a place that the formula
wouldn't consider "usable" for college tuition. What are the
possibilities for having such a safety net that you can get to
instantly, if needed, but not having them be part of the EFC? Should
we move it to one of our Roth IRAs? Keep it in the money market
— Amy W.
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Every family should maintain a rainy day fund for emergencies
regardless of the potential impact on eligibility for need-based
student aid. This provides a safety net for unforseen expenses, such
as auto repair or replacing a furnace, or for temporary unemployment.
A typical rule of thumb is to save 3-6 months worth of income in the
rainy day fund. This rule of thumb is based on the average duration in
unemployment. This rule of thumb also assumes that the family will
reduce spending to just the essentials during periods of
unemployment. Essential expenses include food, clothing, lodging,
utilities, medical care, insurance, taxes and debt payments.
However, this 3-6 months rule of thumb was based on unemployment
statistics that no longer reflect the typical experience of unemployed people.
During the current economic downturn, the duration of
unemployment has increased significantly. From 1948 to 2008, the
average unadjusted duration of unemployment ranged from a low of 1.5 months between recessions to a high of 5.0
months during a recession and for a few years afterward. The maximum
average duration from 2008 to 2011, however, has increased to 9.6
months. The median unadjusted duration of unemployment
followed a similar pattern, ranging from 0.5 months to
3.0 months from 1948 to 2008, with the peak median
duration increasing to 6.0 months from 2009 to 2011. The
percentage of people who have been unemployed for 27 or more weeks has
doubled from a fifth of the unemployed in 2002 to 2008 to two fifths
in 2009 to 2011. These statistics were obtained using the Bureau of
Labor Statistics (BLS) data retrieval tool,
persons by duration of unemployment
. The BLS also published two
unemployment in February 2011
. For additional information, see
Issues in Labor
Statistics: How long before the unemployed find jobs or quit
Accordingly, it may be best to save 6-12 months worth of income in the
rainy day fund. This rule of thumb can be adjusted based on
educational attainment and residential location. People who have a
Bachelor's degree have a duration of unemployment that is about a
third below average. People who live in high unemployment states have
a duration of unemployment that is as much as a quarter above
average. Two-income families may have more flexibility, unless the
couple works at the same company, which adds a risk of simultaneous layoffs.
The rainy day fund should be kept in a liquid form, where the funds
are immediately accessible. There should also be no risk of loss to
principal. For example, one can keep the rainy day fund in a bank
savings account or a money market account. Some people keep the money
in a bank certificate of deposit (CD), since one can withdraw the money
from a bank CD at any time by paying a penalty of 3 months interest.
But it is best to keep at least a few thousand dollars immediately
Asset Protection Allowance (Age 48), 1999-2000 through 2012-2013
A typical rainy day fund will not affect the student's eligibility for
need-based financial aid because a portion of parent assets are
sheltered by an asset protection allowance. The asset protection
allowance varies from one year to the next, but it is typically about
$46,000 plus or minus $3,000 for parents of college-age children
(median age 48). Any reportable assets above this threshold are
assessed according to a bracketed scale, reducing aid eligibility by
at most 5.64% of the net asset value.
(The asset protection allowance is based on the age of the older
parent. It is the present value of an annuity which will supplement
Social Security retirement benefit payments to equal the moderate
family income. It varies annually based on changes in the inflation
Attempting to shelter the money from need analysis may make it less
accessible for emergencies, defeating the purpose of the rainy day
fund. For example, paying down credit card debt or a mortgage may
shelter the money from need analysis, but one cannot rely on credit
cards or a home equity loan during an emergency. Access to credit is
often restricted after job loss.
Sheltering the money may also hurt eligibility for need-based
financial aid. For example, while a Roth IRA may shelter assets on the
FAFSA, any distributions from the Roth IRA will count as income on the
next year's FAFSA. This will artificially increase income and decrease
financial aid at a time when the family is struggling
financially. While a return of contributions from a Roth IRA may be
tax-free, the distribution will count as untaxed income on the FAFSA,
reducing aid eligibility by as much as half of the amount of the