DS will be in college in 2024 Fall. Can someone advise whether contributing (6K) to a traditional IRA for 2022 Fiscal year by April 15th 2023 has any advantage from an EFC perspective ? Saw contradictory articles on the web and I’m confused.
Appreciate your thoughts.
@BelknapPoint can you weigh in on this.
ETA a change! I believe making this contribution will note reduce your taxable income…as it will be added back in as income. If coming out of a bank account…This could reduce your FAFSA EFC by a very tiny bit.
Will it result in you getting more need based aid? Is that what you want to know? If so…the answer is…that is very dependent on lots of other things…like your income anyway. You might be above the threshold for getting need based aid anyway. And also, it depends on the colleges…because there are many many different ways need based aid is calculated. Since we don’t know your total financial picture or the colleges involved…the question of whether this $6000 reduction in your assets will result in increased need based aid cannot be answered (and I’m not asking for the details of your finances).
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Pre-tax contributions to IRAs and 401ks are added back into your income for college financial aid purposes, so it doesn’t help there.
It will be shielded from the “asset” component of the financial aid assessment, but that is only 5.6%, which on $6k is $336.
However, financial aid calculations also take how much taxes have been paid (with more taxes being paid resulting in a lower EFC), and if you put 6k into an IRA that’s 6k less that you paid taxes on, so that will raise your EFC from what it woud have been if you hadn’t contributed that money to your IRA.
Paging @kelsmom in case I misspoke.
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You can learn how the fafsa efc is calculated by working through the worksheet.
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If instead of contributing the $6k to a traditional IRA the money would sit in a reportable account, that will lead to more assets when need-based aid is calculated. A young person saving for retirement is always a good thing, but I’m not sure that financial aid should be the driving concern when contemplating a tax-deductible contribution to an IRA. As thumper1 mentions, there are a lot of variables involved.
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Oh right….the contributions you make to tax deferred accounts are added back in as income…so putting $6000 in an IRA isn’t going to make a difference in your income.
If this is coming out of a bank account…$6000 for FAFSA purposes would be about $336 less family contribution when assets are assessed at 5.6%.
So…really…only do this for your own retirement purposes…not for financial aid purposes.
And again…consider all the other “moving parts” in terms of financial aid.
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Very, very, very few colleges meet 100% of need anyway. So it’s kind of a moot point. Another way of looking at it is that increasing a financial aid award should not be the reason for contributing to an IRA.
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I think this answer is spot on.
However, just to clarify, child will be starting college in 2024, and I believe that contributions to some types of retirement accounts will be handled differently in the new formula and in some cases the EFC/SAI will be reduced; however, as far as I can tell the changes will only impact those who contribute to retirement accounts like a 401k. Contributing to an IRA will be handled similarly as in the old formula.
The case studies that kelsmom posted had this explanation:
Example 5: SAI Lower Than EFC Due to Contributions to Tax-Deferred Pensions
Max is a dependent student with married parents and a family size of four. Their parents’ combined income is $95,000 and they contributed $20,000 in pre-tax income to 401(k) retirement savings accounts. They have $15,000 in savings. Max earns $10,000 and has no assets.
Max’s SAI is lower than their EFC by nearly half. This is largely driven by the changes to untaxed income in the new FM formula. Whereas currently, all contributions to tax-deferred retirement savings accounts like 401(k) plans are treated as untaxed income, starting in 2024-25 only those contributions that are delineated on the tax return, like IRAs, will be treated as untaxed income. This is because of the broader FAFSA simplification effort that uses the FUTURE Act to collect all income data, taxed and untaxed, directly from the IRS. Because contributions to 401(k) plans are not delineated on the FAFSA, they cannot be obtained directly from IRS tax data and, as such, are not treated as untaxed income in the SAI calculation. Other factors contributing to the decrease in SAI vs. EFC include higher income protection allowances under the new FM formula.
Families that make large untaxed contributions to 401(k), 403(b), and other retirement plans that aren’t delineated on the tax return will likely see correspondingly large decreases to the SAI as compared to the EFC.
The draft formula is here and for what it is worth, I found this estimator on the web gave me the exact same result as when I worked my way through the posted draft, but my finances are super simple compared to most.
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Yes, that is one of the changes that will benefit some families. No untaxed income that isn’t on a tax return will be collected on the FAFSA. With some exceptions, families who get Pell grants are typically not in a position to contribute much to pre-tax retirement accounts (they have to use their earnings to meet immediate needs) - so this doesn’t have a lot of impact on federal aid. It can positively impact families for institutional aid (and I think it’s possible that CSS Profile schools will collect & consider this among other untaxed income when awarding their aid … but who knows yet).
Neither the EFC nor the SAI in the example above is Pell eligible. And I would bet that a family of 4 earning $95,000 saving $20,000 in pre-tax 401k contributions is pretty darn rare.
Will this change in the reporting of things NOT on the tax return also apply to schools using the CSS Profile or their own additional form to the FAFSA? As is stands now, there are a number of items on the Profile that already do not appear on the FAFSA (e.g. primary home equity).
Schools that meet full need for all use their own form (Princeton) or the Profile. The only outlier is University of Chicago which has its own very brief form, but uses primarily the FAFSA financials.
As noted above…if you planned to put $6000 in this IRA anyway…do so. If you are doing it in the hopes that it will increase your student’s need based aid…think at least twice.
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I don’t mean to be argumentative since I agree with your general points, but I do think the change will help some families, and I think that is a good thing if only for purely selfish reasons.
As far as I can tell, because the new FAFSA won’t consider some retirement contributions, my D22 will move from receiving a small pell grant (for her freshman and sophomore years) to receiving the maximum pell grant (in her junior and senior years). Of course, it is quite possible that her school, which uses a CSS profile will just reduce other types of aid in response so I’m not holding my breath, but at least for now, I am happy that I do contribute to a retirement account and I think it is a great incentive for middle class and lower income families to try to save in these accounts if they are able. Wealthy and upper income families are already very likely to be able to save for retirement and still pay tuition. The changes to the FAFSA might allow other families to do some of both as well, which I consider a societal good (reducing poverty among the elderly especially given declining social security funds).
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Do you know what percent of taxed assets are expected to be contributed by the student?
For example, my son had several thousand dollars in his savings account from his wages. He has been saving it to pay for college. I started moving it into a custodial Roth IRA because I thought that they might assess it for student contribution at a pretty steep percentage.
The principal can of course be withdrawn at any time as long as he doesn’t touch the gains. So it’s been a convenient place to keep it – also then he knows how much he has available to spend (what’s left in his bank account).
For us, every little bit counts for our income range.
On the FAFSA, I believe student assets are assessed at about 20% of their value towards the EFC. If your son was planning to use this to help with college costs…I’m not sure I understand a problem.
Parent assets are about 5.6%.
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It’s student non-retirement assets that are assessed at 20% on FAFSA, so if work income was contributed to a Roth, that would indeed shelter that saved income for FAFSA purposes. I think this is still true for the FAFSA changes coming next year, hopefully @kelsmom can verify.
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@ColdWombat Re you asking about student retirement assets…or regular student assets.
My response was about regular student assets. Because you did mention a “savings account” and that is not retirement assets.
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Oh no, we don’t have a problem. Our EFC was “reasonable”. I am talking about regular student assets, but we put them in a custodial Roth IRA for the time being. So they are considered retirement, even though he intends to mostly use them for college expenses.
I’m more wondering if it was helpful to funnel the money into the Roth IRA. I think it was, since the student assets are assessed that high. His bank savings account only had like $100 in on the day of the FAFSA, whereas his Roth had thousands.
Every month, we put 80% of his income into his Roth. We front loaded it a bit in October before filling out the FAFSA
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Roth funds will continue to be protected. Contributions in a given year are taxed, so unlike pre-tax contributions, they will be counted as income for that year.
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I’ll take this as an opportunity to plug the custodial Roth IRA. I mostly opened it to give my son a place to shelter his college money. But it’s been great for other reasons.
He likes that he gets to play around with investing. He also likes that he knows that whatever money is left in his bank account is fair game since his savings is in the Roth. He likes the structure of regular contributions. He likes that he knows he can pull money out of the Roth without penalty at any time that he may need it.
I don’t foresee us dealing with need-based aid in the future (kid’s final choices are all merit-based only), and our other kid won’t be applying to expensive schools. But I’m still going to open a custodial Roth for my next kid (he’s applying for jobs right now). It’s a great tool! I got one at Vanguard and the process was a cinch. It will transfer fully to my son when he turns 18, but I’ll probably still help him with it for a couple years if he wants. I bet he’ll keep it around for funsies even after he opens an employer-sponsored plan.
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Thank you everyone for your fast responses with valuable inputs. Very much appreciated. We are able to take an educated decision now. Thank you all, especially @thumper1 , @kelsmom , @BelknapPoint , @MMRose , @Alqbamine32 