Background: To reduce taxes and save for retirement, for a number of years we have regularly maxed out all voluntary income deferral options available to us - 401(k), 403b, IRAs & H.S.A. - so that with $95,000 in gross wages we regularly defer $58,000 +/- income each year through a combination of current wages and some previous savings. We have enough savings on-hand to defer at this level for another two years or so. For 2019, this level of deferral will reduce our tax by about $10,078. The year 2019 will be our oldest son’s first base year for college financial aid - he is currently a high school sophomore and all but certain to apply to schools that require CSS PROFILE. During the 7-years our two children are in college, we plan to pay tuition out of $25,000 +/- annual income saved each year and $38,000 currently in a 529. That is the level of funding we are comfortable with - more or less. We have completed “Institutional Methodology” net price calculators at 50 – 60 “safety, target and reach” schools and net price comes in about $23,000 at most schools (with a few as low as $16,000 and one or two schools as high as $30,000).
Question: If we continue to voluntarily defer $58,000 on $95,000 income during base year, will this effectively lead a prospective FAO to conclude we can afford $58,000/ year tuition since we are making voluntary deferrals at this level each year, or worse that we are dishonest/ are hiding income and trying to game college financial aid eligibility? We wonder if we should stop deferring so much, and pay more tax for a few years, but this does not seem smart, since we don’t know for sure how a financial aid office would interpret our deferrals.
We have read FAO assume any income you are putting into retirement funds in the base year will be available for college instead while your child is in school, but they ignore amounts already in your retirement accounts. This is why if we defer $58,000/ year for base year and for the following year, my concern is a financial aid office will conclude that the same $58,000/ year voluntary deferral can now be paid to cover up to $58,000/ year college tuition, particularly when they see a healthy IRA balance. On the other hand, if I knew clearly that our calculated EFC would be viewed as the primary determinant of what our family would be expected to pay, than we would be comfortable continuing to defer over the next few base years. We are not at that comfort level yet, so feel stuck.
Are you saying that you are putting $58,000 a year into tax deferred retirement plans? Is that what you mean?
I will give you an example. Say you are completing the 2020-2021 financial aid forms. Those forms will use 2018 income tax return and income information. Any contributions you make to qualified retirement plans during the 2018 tax year will be added back in as income for financial aid calculation purposes. So…if you contribute $58,000 to these qualified retirement accounts…that amount will be added back in as income for financial aid calculation purposes. So really…your income will not be reduced for 2018 for financial aid purposes just because you contribute to these retirement accounts.
The colleges using the FAFSA only do not even ask for the balances in your retirement accounts.
Schools that use the Profile…some of them do ask those balances, but there is no evidence that these are used in the financial aid calculations.
BUT your contributions TO those accounts will be considered as income for the tax year used for the financial aid form.
Does that answer your question?
In my example above, your taxable income for 2018 would be reduced…but your income for financial aid purposes would not be.
Oh…the amount contributed to a Roth account would not be added back in…but really, the bulk of that $58,000 is not Roth…right?
Most formulas (FAFSA does) do add back the deferred income from 401k contributions and other voluntary funds (some pension required contributions are not added back) back to income, so in your example the $95k in income is what your income would be for the year. FAFSA only schools do not consider the corpus of the fund, just the tax year in question. It’s not so much that the FAO will consider your deferred income, but that it will be actual income in the formula.
CSS schools can and some do consider 401k accounts, especially if they are overly large.
Since the federal tax paid is deducted from your income when calculating the EFC, why wouldn’t you pay the tax now rather than later (in retirement) during the college years? If you can make use of a Roth 401K then you could even avoid having additional non-retirement assets that count against you.
The point of the statements you quote above on retirement contributions being “available” to pay college costs is simply that they are added back to income in calculating the EFC. You are penalized more for these contributions than for ordinary income because there is no federal tax payment to be deducted in the EFC calculation. But the colleges don’t actually consider whether you are living below your means (i.e. can “afford” to spend more than your EFC) or not. Hence when people (more commonly) complain they can’t afford to pay their EFC the colleges say tough luck.
Hmmm…it’s not that the schools count that retirement account balance money as an asset…they don’t. BUT if the amount doesn’t seem to align with your income…the school is within their rights to ask how that large retirement fund got there.
But as noted…by @twoinanddone and me…your actual income for financial aid calculations will NOT be reduced by the amount you contributed to a retirement account that year. If your in omemwas $98,000…that is what the schools will use. They won’t reduce that income by $58,000 in retirement contributions that year.
I assumed it is $24000 times 2 for the 401ks and 403bs (not sure on limitations of the latter). $6500 times 2 (roths) and maybe $6K times 2 for HSAs. Easily takes OP to the 58K. Assuming over 50.
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he amount contributed to a Roth account would not be added back in<<<<<<
Thank you for all the replies:
I do understand that all deferrals would be added back to come up with a total income for the CSS/ PROFILE - so the deferred income would not effect our EFC.
What I am concerned about is that by showing we are able to voluntarily defer such a high % of our income - $58,000 each year on $95,000 income - effectively living below our means - that by deferring so much we would be conveying to a FAO that we are able to pay much more than what their particular EFC calculation would normally determine for someone at our income level. An even worse scenario I can imagine is that a FAO concludes that we are in some way gaming the system by hiding income (since most do not live so below their means and happen to have savings to be able to defer such a high percentage of income) or that our priorities are not showing adequately since we are not saving more for college, but are saving for retirement/ reducing tax liability.
thumber1 $58,000 deferrals are as follows. When the second of us turns 50 in two years more available.
401(k) $19,000 (in 2 years additional catch-up contributions of up to $6,000)
403b $19,000 (in 2 years additional catch-up contributions of up to $6,000)
HSA $7,000
IRA (x2) $13,000 (one of us is 50 y/o)
Are you anticipating that your kids will both get accepted to colleges that meet full need for all accepted students?
If they don’t…all these financial gymnastics might not matter one bit…because your kids might only get a Direct Loan and no other need based aid.
And adding…your eldest kid is not starting college for three years. Financial aid awarding policies do sometimes change. In addition, costs very likely will be higher than they are now.
Really the point will be that you may need some of that money to be easily accessible to pay for college when the reality of the financial aid offers roll in. Consider having options that are not punitive if you need to liquidate them. Your income is your income on the aid application.
I think your concerns about looking bad/gaming the system are unfounded. But as noted above, paying the tax in 2019 would improve your EFC. Also note that the Profile will consider home equity at many schools so your EFC may be quite a lot higher than the FAFSA calculation if a paid off home is one reason you are able to live so cheaply.
EDIT: sounds like you are aware of differences in the Profile. If you will not defer $25K per year during college, then if you start that in 2019 you should see about a $2K improvement in your EFC. Just defer it in the last years of college instead when it won’t impact EFC.
I get that we will want to have enough funds on hand to pay tuition and so we might not want to defer so much over the next 2-years so we have more options. This is our plan at this point - we are all ears for suggestions if it is unrealistic! During the 7-years our two children are in college, (starting in 3-years) we plan to pay tuition out of $25,000 +/- annual income saved each year and $38,000 currently in a 529 - so that would provide about $30,000 each year for 8 years of tuition. That is the level of funding we are comfortable with - more or less. We have completed “Institutional Methodology” net price calculators at 50 – 60 “safety, target and reach” schools and net price comes in about $23,000 at most schools (with a few as low as $16,000 and one or two schools as high as $30,000).
RE: Are you anticipating that your kids will both get accepted to colleges that meet full need for all accepted students?
Our oldest is a driven type, strong student with high test scores and GPA, so we are more confident in his being accepted at a meets full need school. If not, as mentioned above, we have limits on what we feel comfortable paying, so he would have to lower his sights to a less competitive school, to the point where he was eventually attractive enough to admissions to be able to enroll . Our State schools are currently at $24,000/ year, one of which is very selective.
our youngest has another 6-years to go, and at this point we do not see it as likely to go beyond the state college level of funding.
I hope we are not doing “financial gymnastics”! At least is does not feel that way. We enjoy living simply and consider saving, tax/ financial planning a worthwhile pursuit.
Most schools don’t really care what you do with your personal money. You can smartly save it in a 401k or you can spend it all on the mortgage or even squander it on food and electricity. You make what you make. What they really care about is that your annual income is $95k ( and your assets, including the 529). There is a formula for what people who make $95k should get in financial aid.
If your kids get into Stanford or Princeton, it’s likely they won’t care as they’ve pledged full need for those making under $125k.
For FAFSA, just like CSS, the contributions to those various retirement funds will get added back in to total income, so your EFC would be affected. So, instead of the smaller income, the bigger income would be used to determine EFC.
Thanks for the replies:
I do understand that any IRA/401(k) contributions would be added back as income for FAFSA and CSS ie: if we earn $95,000 and contribute $58,000 into retirement accounts, then for tax purposes, our earnings would be $37,000 ($95k - $58k), but for both the FAFSA and CSS our earnings considered available for college would be considered $95,000 since all voluntary retirement contributions would be added back in (unless they were Roth, since Roth contributions are after tax and so would already be included in original earnings calculation).
My concern and question is rather if by voluntarily contributing such a high percentage of income to retirement accounts during base year ($58,000 in contributions on $95,000 earnings) we would be conveying to a FAO that we are able to pay much more than what their particular EFC calculation would normally determine for someone at our earning level - ie: a FAO might logically conclude since we were able to save $58,000 for retirement on $95,000 earnings in base year, we should be able to direct the same amount - $58,000 - to college during the years our sons are in school. An even worse scenario I can imagine is that a FAO concludes that we are in some way gaming the system by hiding income (since most do not live so below their means and happen to have savings to be able to defer such a high percentage of income) or that our priorities are not showing adequately since we are not saving more for college, but are instead saving for retirement/ reducing tax liability. In our situation, we live below our means and have enough savings to contribute at this level to retirement accounts which will save us $10,000/ year in taxes over the next 2-years.
Twoin18 feels my concerns are unfounded which is promising - thank you for taking the time to understanding my question and sharing, Twoin18. However if there are others who have direct knowldge can confirm that our concerns are unfounded, or how we might determine if they are unfounded, we would be most appreciative.
I really don’t think FAOs spend that much time looking at every entry. You enter your info, the FAFSA spits out an EFC - whether you’ve saved any of it in 401k or HSA, they expect you to pay that EFC (or a lot more).
On the CSS, they see your income, they see the total in 401k accounts, but they don’t know if you put that all in a year ago or 15 years ago. Yes, they could do the math on every single entry, but most schools are processing thousands of CSS forms every year so use a formula. If the numbers add up, they move to the next file. I think your kids will get the same FA as other kids whose families make about $100k, except that amount paid in taxes does play a part in the formula so you won’t get as much ‘credit’ for taxes paid (because you didn’t pay them).
Yes, they are unfounded. It is no different if you put the $58K in a pile and lit it on fire each year. FO’s don’t care how you spent your money in the past. You just spent it on your future retirement.
I agree that they will not alter your package on perceived ability to pay a higher amount. They will rely on the calculations. We also employed the pre-tax method heavily for a number of years to reduce current taxes. We have access to two 403bs and a 457 plan. We’ve had to scale back to pay for private secondary school and will do even more leading into college. I just filled out the FAFSA for the first time and the details of line 12 of the W2s were asked a separate item requested.
Your concerns are unfounded. The financial aid departments will use your full income to determine your need based aid. If you choose to put 2/3 of that into retirement accounts…that is your business. They won’t care.
The schools will calculate your net costs and send you a bill. As long as you can pay the bill, you are good to go.
To your business whether you decide you need some of the $58,000 retirement contributions to help pay college costs…not the college’s.
I do think you are putting the cart before the horse. If you kids don’t get accepted to colleges that meet full need for all…all bets are off in terms of what your family contribution will actually be…in three years.
Like I said…costs will increase for sure. The results from the NPCs now may not be the same in thre years.