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Retirment Contributions Misunderstood in Financial Aid
June 6th, 2009
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by Scott Anderson · Filed Under: Financial Aid
Twice in this past week, I saw comments on one of the large online college prep forums about people making IRA contributions so they could lower their income as reported on the FAFSA form. There’s a really big problem with this… it doesn’t work. The FAFSA (free application for federal student aid) doesn’t work that way.
This is symptomatic of one the bigger problems with the FAFSA, and that is people equate tax regulations with financial aid regulations. In reality, they have very little in common.
Making contributions to retirement accounts (IRA’s, Roths, 401k’s, annuities, SEP’s, Keogh’s, etc) does nothing to lower income reported on the FAFSA form. The form specifically asks about money contributed to these types of retirement accounts so it can be added back into the calculations.
The FAFSA wants to know about any discretionary, pre-tax contributions. These contributions are considered available money since the parents or the student have control over whether or not they make the contributions. And therefore, they are considered fair game. This does not include contributions to traditional pension programs. Those contributions are controlled by employers and are not considered
available money.
Part of the confusion is money already in the retirement account is not considered on the FAFSA. For example: a parent makes $5,000 and saves the $5,000 in a savings account. The $5,000 will be assessed as income, and it will assessed as an asset because it is in a savings account. However, if the parent takes the $5,000 and puts it in their 401k; the income will still count, but the asset value in the 401k will be excluded.
Many individuals conclude that if the asset value is not counted, then the contribution from income must not be counted as well. As you can see, that is incorrect.
So how do you mitigate the effects of income on the financial aid forms? Well unfortunately, unless you are a business owner or farmer, you really don’t have much flexibility in the income arena. So far, I’ve never found anyone who thinks it’s a great idea to take a $10,000 pay cut, so I can save them $5,000 on college.
