Impact of 401(k) on EFC?

Paying for College
1

<p>I realize that both fafsa and profile adds back the voluntary contributions to a 401(k) in the year that they are made, but what about net of taxes?</p>

<p>For example, a $100k income family, at 30% marginal tax rate (fed+state) considers deferring $10k into thier 401(k), or not. If not, then the last $10k of income less $3k in taxes, nets $7k, of which approx 50% (for simple math) increases efc. In this rough example, efc would increase by $7k*50% = $3,500, correct?</p>

<p>However, what if that last $10k (or a bonus of same amount) is put into a 401(k) instead. Is the full $10k is added back for efc calculation, resulting in increased efc of $5,000? And, will the efc increase even more bcos of taxes saved? For example, the $10k deferral will also decrease this taxpayer's taxes due this year by $3,000, resulting in more disposable income. Does that $3,000 also result in an increase in efc of $1500, making the total efc effect $5,000 + $1500 = $6500?</p>

2

<p>Heavens - my brain hurts just reading the question!!</p>

<p>The (non Roth) IRA contribution reduces the AGI on the tax return by $10,000. </p>

<p>On the EFC formula worksheet the AGI is on line 1. The IRA contributions (the untaxed gross of 10,000 not the net 7000) are added back on line 4. Line 7 = total income. Actual federal taxes paid are deducted on line 8 (so not changed to reflect the change to income from adding back the contributions). On lines 9 the allowance for state tax is deducted and is calculated based on total income (line 7) using table A1 (so is based on the increase of income from adding back the contribution).</p>

<p>So my interpretation would be that the income added back would increase your EFC by between 22% up to 47% (depending on your income level after income protection on table A3 and percentages of AAI on table A6) but that income may be reduced a little by the state tax allowance.
For instance if you live in Oklahoma the State tax allowance is 5% so the $10,000 added back would be reduced by 5% to $9500 which would cause an increase in EFC of between
2090 (at the lower level of 22%) to 4465 (at the higher level of 47%).</p>

<p>Just my interpretation from looking at the FAFSA EFC formula at
<a href="http://ifap.ed.gov/eannouncements/attachments/0809EFCFormulaGuide.pdf%5B/url%5D"&gt;http://ifap.ed.gov/eannouncements/attachments/0809EFCFormulaGuide.pdf&lt;/a>
I need a nap now.</p>

3

<p>Basically, your assumptions are correct, but because you allowed for such a high amount (50%) in calculating how much it would increase your EFC, it doesn't truly demonstrate the advantage of the tax deferred money. </p>

<p>If you put $10,000 into a 401k your EFC will be increased by a percentage of the full $10,000. </p>

<p>If you do not put the money in a 401K, the taxes reduce the income for calculation purposes, so your EFC will increase based ona percentage of the $7000. </p>

<p>Using your hypothetical 50%, your calculations show an increase in EFC with the 401K of 6500 and without 3500, but you fail to add back the $3000 you saved, basically appearing as a wash(6500 in each scenario) but unless full need is being met you are still better off knowing you'll get that $3000 in returned taxes. Plus if your assets are close to the asset protection allowance, you are now increasing assets $7000 (10,000-3000 in returned taxes). This would add another 12% of the 7000 equaling an additional 840 to your available income. and a percentage of that 840 would increase your EFC further. </p>

<p>However, try recalculating with more realistic percentages and the numbers definately fall in favor of the 401K. I'm not exactly sure percentage of available income is used, but it's somewhere between 25-30. I'll go with the higher amount. </p>

<p>You put $10,000 into a 401K, your EFC increases by $3000, but you've also saved 3000 in taxes. Basically a wash take the 3000 and put it towards college expenses. </p>

<p>You don't put $10,000 into 401K, you pay 3000 in taxes, and your EFC increases by 30% of the 7000, another 2100. So now you are out 5100. Plus, that 7000 you decide to put in the bank will further increase your EFC by 30% of the 840 (12% of unprotected assets), amounting to another $252 for every year that extra 7,000 is in your bank account.</p>

<p>So, while your assumptions were correct, the use of 50% for simplicity purposes did not give a true picture.</p>

4

<p>For higher income levels (income over $27,800 after protected allowances) the % is actually 47% so, with a $100,000 income the OP is pretty close in using 50%.</p>

5

<p>For higher income levels (income over $27,800 after protected allowances) the % is actually 47% so, with a $100,000 income the OP is pretty close in using 50%.</p>

<p>If the $10,000 is not put in an IRA:
You start off with $10,000. You pay $3,000 taxes leaving you with $7,000. The impact on EFC (at 47%) is 3290 (plus possibly another 392 if the $7000 is invested as an unprotected asset).
So of the original 10,000 you would spend $3000 intax and 3290 on EFC leaving you with $3710 (not including any impact it would have as an unprotected asset). </p>

<p>If the $10,000 is put in an IRA:
EFC impact is still 3290 but you save $3000 on taxes and the asset is a protected asset. So of the $10,000 you would have $6710 left albeit not easily accessible) .
So overall you are still better off putting the money in an IRA if you can.</p>

6

<p>(necro)
@Swimcatsmom - the $3k in taxes you this year is not permanently saved, just deferred. It is likely that at some future day you will have to pay some (hopefully not all) of that savings back when you withdraw the money from the IRA.</p>

7

<p>Yes, I am quite aware of that as my husband is retired and we have been withdrawing money from his IRA for some time. In most cases, a persons tax rate will be lower in their retirement years that during the later high earning days of their career. </p>

<p>Do you realize this thread is more than 4 years old? I am not sure why you felt is necessary to resurrect it.</p>