By Liz Weston
LOS ANGELES, Jan 27 (Reuters) - Spiraling college costs can tempt families to stretch the truth trying to get more financial aid. These methods carry significant risks and may not even work.
There are legitimate ways to get better offers (see), but here's what you want to avoid:
1. Lying about income
Tempted to "forget" an income source or report lower numbers than what you actually earned? The chances of getting caught are fairly high.
Colleges can, and do, compare the numbers you submit with the transcript of your most recent IRS tax return.
In the past, the U.S. Department of Education required colleges to verify 30 percent of the Free Application for Federal Student Aid (FAFSA) submitted, but some choose to verify 100 percent, said financial aid expert Mark Kantrowitz of Edvisors, a Las Vegas-based education resource network.
Going forward, the department is transitioning to a computerized risk model to flag potential problems that will require applicants to provide further proof if there are any discrepancies.
Just as lying to the Internal Revenue Service carries substantial penalties, so too does lying on a FAFSA - a fine of up to $20,000 and up to five years in prison.
2. Hiding assets
Many attempts to keep wealth hidden from the financial aid process are pointless, said Kantrowitz, who co-authored the book "Filing the FAFSA."
Parents with substantial assets often also have substantial incomes, and high incomes are often enough to rule out getting need-based aid.
Also, assets tend to leave a paper trail. If you cash out stocks to stuff money into your mattress, the capital gains will show up on your tax return. Financial aid officers are pretty good at spotting discrepancies and inconsistencies, and may ask you to provide several years' worth of tax returns and account statements if they smell something fishy, said Kantrowitz.
Keep in mind that retirement assets are never counted in financial aid formulas, and a certain amount of non-retirement assets are also sheltered from inclusion by the FAFSA when determining your expected family contribution.
The vast majority of families won't have enough assets to affect their chances of getting financial aid, said college expert Lynn O'Shaughnessy of San Diego, author of the book and Web site "The College Solution."
3. Buying annuities and life insurance to reduce assets
Insurance salespeople may pitch their products as ways to make non-retirement assets "disappear," said college planner Todd Weaver of Strategies for College, a Hanover, N.H.-based consulting firm. Some go a step further and suggest you borrow against your home equity to invest in annuities or insurance -which is rarely a good idea, since the federal financial aid formula ignores home equity and private colleges typically cap how much equity they count.
"People get lured into thinking that assets are the driving factor" in financial aid offers, Weaver said. "They're not. It's income."
Where life insurance is concerned, it's true that financial aid formulas don't count the cash value, said college consultant Deborah Fox of San Diego-based Fox College Funding. But cash-value policies can be expensive and aren't a smart purchase if you don't otherwise need the coverage, she said.
Annuities also can be expensive and come with surrender charges that make it costly to get your money back. While they're not counted in the federal financial aid formula, private colleges may count them against you.
"More colleges are counting them," Fox said. "Annuities are not necessarily a safe haven."
Families considering either product should first use an "estimated family contribution" calculator, like the one atas well as colleges' net price calculators to see if the purchase would make a difference. Then they should run the idea past a fee-only financial planner, a certified public accountant or another financial adviser who doesn't stand to make a commission on the deal.
4. Saving in Grandma's name
Assets in the student's name count heavily against financial aid offers. Assets in the parent's name count much less heavily. Assets in the names of grandparents or other non-custodial relatives don't count at all, which is why some people have Grandma open 529 college savings plans for the grandchildren.
That may work okay the first year for financial aid, but withdrawals from that college savings plan to pay for college will count as a "student resource" that will significantly impact the next year's financial aid offer, said CPA Joe Hurley, founder of SavingForCollege.com.
By contrast, withdrawals from parent- or student-owned 529 plans usually aren't reported as income for financial aid purposes. Typically, Hurley said, it's best to save in the parents' names.