<p>I'm going to be in college next year that means 2013 is the base year for me. If my parents contribute $10K for this year in IRA and $10K for next year early next year, let's say in Jan 2014, Will it reduce EFC?</p>
<p>No, it will not reduce your EFC as the monies will be added back as income.</p>
<p>I understand that. But next year this year’s contribution will be insulated. The year in which the contribution is made gets added to EFC, it then becomes part of your IRA/401K and does not get added to EFC formula.</p>
<p>My question is: What is the best way to contribute to IRA outside of 401K to minimize net EFC for the four years you are going to be in college.</p>
<p>For individual IRA, there are two kinds: Traditional and Roth. Traditional IRA can be contributed pre-tax and Roth post-tax. For traditional IRA, you have to add it back to you income as it is, oh, pre-tax. Roth, as post-tax, does not need to be added back. Once the money is in an IRA, it is insulated and won’t be included, as asset, into EFC calculation.</p>
<p>Which way is better? There are a lot of factors:
- What is your parents’ tax rate?
- Will it be possible, in the future, that you parents want to use the money in IRA for education expenses?</p>
<p>If answer to 2 is yes, Roth is a better choice as you can withdraw money from Roth for education without penalty. You have to pay penalty if you want to use Traditional IRA money even for education (double check this, not 100% sure), though you can convert to Roth first and then withdraw.</p>
<p>In the end, it does not make too much difference which IRA to contribute in terms of calculating EFC. Your parents should consider which IRA will help their retirement better.</p>
<p>If you contribute ( before tax )to a retirement acct while filing FAFSA, that money will be added to available income.
No way around it, that I’ve seen.</p>
<p>Which kind of IRA? Roth IRA contributions will not be added back in as income as they are not pre-tax or above the line deductible. For traditional IRAs, only the amount of line 32 on form 1040 will be added back in to income. That amount can vary depending on your parent’s income. Making these contributions could reduce your EFC but only if this $20k plus your parent’s other assets exceed the parent asset allowance. The asset allowance varies based on the age of your oldest parent. See Table A5 and the entire fafsa formula here:</p>
<p><a href=“http://www.ifap.ed.gov/efcformulaguide/attachments/091913EFCFormulaGuide1415.pdf[/url]”>http://www.ifap.ed.gov/efcformulaguide/attachments/091913EFCFormulaGuide1415.pdf</a></p>
<p>You income for,the year will NOT be reduced by any IRA.</p>
<p>The IRA money in the IRA accounts will not be considered an asset.</p>
<p>However, EFC is heavily weighted towards income. </p>
<p>You may be doing these financial gymnastics for no reason if your parents’ incomes are sufficiently high.</p>
<p>From an asset perspective, if the $10,000 x 2 would otherwise be in a savings account that are not protected then putting it in an IRA would reduce your EFC by up to $1020 (depending on whether their assets exceed the amount of their asset protection).</p>
<p>As far as income is concerned the impact would depend on whether it is a Roth or as traditional. Contributing to a Roth would have no impact on the EFC. Contributing to a traditional IRA could actually increase the EFC a little (because it reduces taxes which are an allowance against income in the EFC formula).</p>
<p>***From an asset perspective, if the $10,000 x 2 would otherwise be in a savings account that are not protected then putting it in an IRA would reduce your EFC by up to $1020 (depending on whether their assets exceed the amount of their asset protection).</p>
<p>The money can be invested in ROTH or IRA. The money will not be withdrawn in near future.</p>
<p>The point of asking my question is, you can invest 20K, 10K for this year right now and 10 K for next year In Jan 2014, the money which otherwise would be sitting in a saving account.</p>
<p>What’s the best way so it doesn’t count towards EFC.</p>
<p>My parents would definately like to invest in IRA as it gives them tax break as it reduced your AGI. The question is can the timing of investment be used to your advantage.</p>
<p>If the money (20k) is from this year’s income, there is no way to hide it as income, because it is either added back to income if contributing as Traditional IRA or it is already included in their income and taxed if contributing to Roth.</p>
<p>If the money (20k) is from your parent’s saving (assets, not income), putting it in to Roth or Trad IRA will definitely reduce your EFC as it is insulated, as you mentioned. In this case, as mentioned by swimcatsmom, you can reduce your EFC by up to $1020.</p>
<p>The system punishes people who (can) save their income as assets, because it first reduces EFC by up to 47% (?) of income and then up to 5.64% assets if you save the income as assets. So putting money into IRA (roth or traditional) is definitely beneficial to your family.</p>
<p>Furthermore, Roth will reduce EFC by a little bit more because you pay more tax in year 2013, which is deducted from your EFC calculation. How much is to save depends on your family situation.</p>
<p>When they ask you for your savings assets etc. Is that as of 12/31/2013 for the college year 2014? </p>
<p>Or you write down what the saving balance is at the time of filing FAFSA/CSS?</p>
<p>At the time you file FAFSA, you state what is in your accts.</p>
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<p>For a traditional IRA it doesn’t really matter where the money comes from, current income or savings(you do have to have enough earned income to cover the amount put in the IRA). What matters is whether or not the amount is deducted before AGI is calculated. Whatever the source, an amount deducted will be added back into AGI for a traditional IRA.</p>
<p>The other point that we have made is that you only get an EFC benefit for asset reductions over the parent asset protection allowance. For example, if your parent’s asset protection allowance is $36k and total assets are currently $40k, putting $20k in the IRAs will only gain a $4k asset reduction in the EFC calculation. That would be about a $224 EFC reduction, disregarding the income aspects. In this example your parents would have to have $56k total assets to see the full benefit of the asset reduction.</p>
<p>Collegebound1111, I would suggest that you buy a 2013 tax software, such as TurboxTax and enter your numbers for year 2013. Then do you EFC calcuation on the form ‘annoyingdad’ posted to see what your EFC is actually is based on different IRA contributions. This will definitely gives you accurate information.</p>
<p>Once more with vigor…the family contribution calculated by colleges is VERY heavily weighted towards INCOME. If your family has $20,000 sitting around that they can divert to an IRA, it is VERY possible that their INCOME is already too high for all of this to matter at much.</p>
<p>As Swimcatsmom pointed out…having that $20,000 in an IRA would save you a whopping $1020 of family contribution. </p>
<p>To be frank…you might better spend your time looking for a school year, vacation and summer job.</p>
<p>Thanks Guys</p>
<p>I think ROTH might be better as that won’t reduce your taxes and tax amount is substracted from the EFC? As for as excluding the money from assets is concerned whether it is in 401K or traditional IRA or Roth, it will be the same. Correct?</p>
<p>The balance in ANY IRA or TSA is not counted as an asset. </p>
<p>Before your parents make this transfer, be SURE that they do not need the money for other purposes. </p>
<p>Again…is this really worth it to them to save $560 per year on your family contribution?</p>
<p>For FAFSA, all retirement accounts are protected assets (Roth, traditional, 401K). If the school requires CSS or some other additional form, the retirement accounts may have to be reported there.</p>
<p>As far as Roth vs Traditional, you need to look at the whole picture. You are taking a very narrow viewpoint by only considering the EFC impact. </p>
<p>A simple example. If you contribute $10,000 in year 1 to a traditional IRA and your marginal tax rate is 20%, then you would save $2000 in taxes (and possibly some State taxes depending on your State). That reduction in taxes might cause your EFC to go up a little because it causes your available income to go up a little. The **maximum **% of income that usually goes to the EFC is around 47% (for those with high incomes). So the $2000 less tax would possible cause your EFC to go up by 940. So you give up a $2000 tax savings to reduce your EFC by 940? From an immediate cost benefit viewpoint, I would take the $2000 tax break. Even if you qualify for aid, you are spending $2000 to potentially get $940 IF the school meets full need.</p>
<p>My personal take would be to go with the type of IRA you would prefer. If you would prefer to take the tax hit now and have the money be distributed tax free, go with the Roth. If you want the tax break now and would rather pay the tax when it is distributed, go traditional.</p>
<p>I think you are playing a lot of financial gymnastics that may not benefit you at all.</p>