Right now, the pandemic is causing chaos and uncertainty for colleges and students. But it won’t always be that way. And if you have children who will be heading off to school in the next few years, you’re probably thinking about more typical concerns – such as expenses. How will you pay for the high costs of higher education?
Most colleges do offer financial aid packages that can greatly help with these expenses. But it pays to know, well in advance, how financial aid works. And the key platform for determining much of your child’s financial aid is the Free Application for Federal Student Aid (FAFSA). In fact, if you have children starting college next year, now is the time to get going on the FAFSA, which became available Oct. 1 for the 2021-22 award year.
Filling out your FAFSA will provide you with what’s known as your Expected Family Contribution (EFC). The EFC calculation takes into account four separate areas: parent income, parent assets (excluding retirement funds, such as 401(k) plans and IRAs, home equity and small family businesses), student income and student assets. The EFC does not calculate the exact amount you must pay for college – rather, it’s an estimate, and the amount you pay can be below or above this number.
Nonetheless, the EFC is important in determining your financial aid package, and your actions can influence the results. Here are a few suggestions for future years:
- Save money in your name – not your child’s. FAFSA will just consider up to 5.64 percent of a parent’s assets, compared to 20 percent of a student’s assets.
- Be aware of how retirement plan contributions can affect aid. Many of your current assets, such as your retirement accounts, may be excluded from the EFC calculation. However, any voluntary contributions you make to your 401(k) or traditional IRA during the “base” year (the prior tax year) generally must be reported on the FAFSA and are counted as untaxed income; consequently, these contributions may have a similar effect on aid eligibility as taxable income. Mandatory contributions, such as those made by teachers to a state retirement system, are generally not reported on the FAFSA.
- Avoid withdrawals from your 401(k) or traditional IRA. The money you take out from these accounts in the years you fill out the FAFSA, and the prior tax year, may count as taxable income in the financial aid calculations. If you really need the money, you may want to consult with your financial professional for alternatives.
- Consider having children put earnings into a Roth IRA. Money from after-school or summer jobs your children put in a Roth IRA may not be included in EFC – plus, your kids will get a head start on a tax-advantaged retirement account. Keep in mind, though, that Roth IRA withdrawals could be considered as taxable income on the FAFSA if the account owner is younger than 59 ½, which will be the case for your children, or the account is less than five years old.
Not all these suggestions will be appropriate for everyone, but they’re worth thinking about. You might also want to consult with a college’s financial aid officer before you complete the FAFSA, as aid calculations can be complex. An investment of your time and effort early in the process may pay off when the aid packages are finally delivered.
This article was written by Edward Jones for use by your local Edward Jones Financial Advisor. Edward Jones, Member SIPC
Edward Jones, its employees and financial advisors cannot provide tax or legal advice. This content should not be depended upon for other than broadly informational purposes. You should consult your attorney or qualified tax advisor regarding your situation. Make sure to discuss the potential financial aid impacts for your specific situation with a financial aid professional.
Sean Payne, CFP® can be reached at (562) 596-3722.