<p>I've only posted on CC a few times but have gotten great responses. I'm hopeful for some insight on my newest quandry.</p>
<p>It's my understanding that financial aid determinations will be based upon the parent's income level including contributions to an IRA being added to any gross figures. I guess the presumption is that IRA contributions could have been used to help fund college.</p>
<p>In any case, if IRA contributions are factored in to the aid calculations, then how would IRA distributions be considered. Would they be excluded from income (despite their inclusion) on 1040 income figures.</p>
<p>Correct me if I'm wrong but it looks like IRA contributions diminish fininancial aid in the year of contribution and also diminish financial aid in the year of distribution (Isn't that some form of "double dipping"?) Assuming the above to be the case, is it unwise to distribute IRA $$ when receiving financial aid.</p>
<p>Assuming your IRA contribution is not a Roth IRA, I don’t look at it as double dipping. IRA contribution is a legal way to shelter some income from tax and reduce AGI. FAFSA and college financial aid is saying that you cannot reduce your income for the purpose of determining financial aid by contributing to an IRA. IRA (non-Roth) distribution is simply an income from tax-deferred money, and it is treated as such by the financial aid rules. Bottom line, it is advantageous to delay your IRA distribution during college years if you can afford to do so. And for IRA contribution, while it does not reduce your AGI, it reduces your asset amount in current and subsequent years, again if you can afford to put away the money.</p>
<p>Did you read my last sentence? Less asset generally means more financial aid. $5000 a year means you will have $5000 less in asset on the first year, $10000 less on the second year, and so on…</p>
<p>I did read your last sentence. As a youth, I was often accused of being a poor listener. As an adult I’ve been labeled a poor reader. In my waning years, I find that I’m just poor. I’m just trying to remedy that. Nothing I can do about the listening or reading.</p>
<p>If the IRA is deductible, it will lower your taxes paid, which in essence raises your income. This is then “taxed” by FAFSA, and depending on your tax brackets and FAFSA brackets you may or may not be better off making the contribution.</p>
<p>For example, say you are in the 33% combined fed and state tax bracket and the 47% FAFSA income bracket and 5.6% asset bracket. </p>
<p>You contribute $4K to a deductible IRA: You save $1320 in income taxes, which increases your EFC by $620 (47% of $1320). Over 4 years this adds up to $2480 in extra EFC.</p>
<p>You don’t put $4k in the IRA: Your taxes don’t go down, which doesn’t increase your EFC, but you have $2680 in new assets after taxes, which increases your EFC by $150 (5.6% of $2680). After 4 years your EFC has cumulatively increased by $150 + $300 + $450 + $600 = $1500.</p>
<p>So the net effect is that contributing to a deductible IRA adds $980 to your EFC over the 4 years and (you have $16,000 in your account when you are done which you will owe taxes on some day) or you save $0 in EFC and have about $11000 sitting in the bank which you won’t owe taxes on.</p>
<p>So there is a slight EFC penalty if you contribute to a deductible IRA, given the stated assumptions. That might change depending on which brackets you find yourself in, you’ll have to run the numbers for your own situation.</p>
<p>There is a FAFSA EFC formula. You have a certain amount of protected income (based on number in family, number in college). For the remaining income there is a table that shows the % of the income that will go to the EFC. It ranges from @ 22% up to a certain level then higher percentages of income over that level, topping out at a maximum of 47%. The income level for the 47% is not that high. Someone in a 33% tax bracket would likely reach that level of income. (but it would not be 47% of all income - just of the income over that cut off point).</p>
<p>Sorry swimcatsmom, I deleted my post. I just looked it up and I think I understand now. So, from this analysis for people with income above the cutoff, we actually have a net loss in financial aid if we contribute to IRA. I think you still have net positve when taking into account the income tax saving, but that is very discomforting to think that you need to pay more college cost when contributing to retirement during your children college years.</p>
<p>Not rich enough. I understand. At least I think I understand. I had to read your post a few times but in the end, it seems at least for the example you presented, contribution to the IRA increases the EFC over the 4 college years. Just to make sure, I take it that in your calculations the FAFSA EFC is determined on the basis of net income(which would exclude the IRA contribution)+ the IRA contribution. </p>
<p>Wow, I never thought of that.</p>
<p>In fact, I’ll have to read your post again, just to make sure I have a working knowledge of this concept.</p>
<p>Thanks again, not exactly what I asked but certainly more than I asked for.</p>