Pension and Taxes and Profile, How Do They Account for it?

I realize all forms ask for the parent contribution to a pension plan 401k, 403b or IRA and add that money back in to your income. Makes sense to me up to a point (more below) and I understand that contributing to retirement is discretionary income.

I also know that all schools ask how much you paid in taxes during the reference year and that reduces your income by that amount.

So if a couple in their 50s contributes 20k each to their retirement, thereby saving roughly 13k in taxes, and that 40k gets added back into their available income, is it reduced by the 13k they would have paid in taxes on that money they put away? Otherwise it does not seem fair. Am I missing something?

Separate issue: The reason I said up to a point is because I do not believe that teachers, government workers and anyone with a traditional vested pension plan pay the same penalty. I realize it is their employer saving for them and they do not have a choice but I am putting money into a 401K because I do not have a choice either, unless I want to eat cat food at age 80! Someone in their 50s who has worked at these companies/agencies/districts is already vested and has a guaranteed retirement account and does not have to save the same way. Does the formula account for that?

No, the taxes you paid are what is credited, not the taxes you would have paid if you didn’t take deductions and credits.

No, the pensioned employees may have benefits that you don’t. I may have benefits that you don’t. You may have tax credits that I don’t. The formulas are created for the most common situations.

The most common situations are that there are still a significant number of people with traditional pensions, and it is not accounted for. There are some states where some crazy percent of the population works for the government, whether federal, state or local.

As for 401ks in general, follow my math. Lets say we make $120,000 gross with 2 kids in private college meeting full needs. However husband and I are over 50 and put a total of $40,000 in retirement plans because we know our dear Ks are probably not going to support us! So we are left with 80k and after deductions we pay $20,000 (just using an example) in taxes. So our available income is $60,000 for FA.

If we had decided not to put anything away we would pay another $13,000 in taxes, so a total of $33,000 our available income for financial aid purposes would be 120-33 = $87,000

However we did do 401ks and the school adds back the $40,000 we paid so they calculate our available income as $60,000 + $40,000 = $100,000.

So we are worse off from a FA point of view. I guess the argument is that we did not have to pay those taxes but essentially whatever we did not pay in taxes, we may lose in FA and we have to accept the restrictions that a 401k places. Plus 401ks are not tax free but merely tax deferred and the government has a vested interest in people saving for their retirement, that whole social security is not going to be available forever we have been hearing since we were kids. So perhaps this needs to be adjusted at least on the federal forms unless it is already accounted in some way

Federal employees pay 0.8% of their pay into a pension, and then pay regular FICA taxes. (There are a few federal employees on the old system, but the switch was made in about 1980, so most of those employees have retired or are close to it) It is a post tax contribution so it is included in your income.

The employer match for the 401k is not counted on the FAFSA. It is similar to an employer paid pension in that it is totally free money and not counted on the FAFSA. Free money. I really do see that as a 10% raise that I’m not dinged for on the FAFSA.

The FAFSA and the IRS aren’t really coordinated. The IRS gives you all kinds of tax breaks and credits the FAFSA formula really doesn’t care about and that some schools that use the CSS also don’t care about. IRS allows business deductions and the FAFSA/CSS formulas say ‘not so fast, those are to be added back in.’ The IRS doesn’t care about child support payments and the FAFSA does and says ‘that child is being supported and that money counts.’ The IRS gives a pre-tax benefit for 401k contributions and the FAFSA formula says, ‘oh no, that’s income to us right now, not in 20 years when you withdraw it.’

I was thinking of teachers and local and state government workers who depending on the state still have a traditional pension that they do not contibute to and in many suburban school districts get nice salaries. In addition they can do an annuity but that is voluntary and is similar to a 401k.

Unfortunately, if you only have an IRA (work for a small company or part time) or are self employed there is no free money! Plus the match is only 4%.

The basic rule behind the IRS formula is someone has to pay. It is a balanced system. I do not know enough about child support to talk intelligently about it.

The problem is that CSS may say that is income to us right now, but if you had not contributed it, your income would have been $13K lower so that entire $40K would never be available to pay for college so why treat it like it is. It is a simple matter to calculate the taxes now (that you would have owed) since you are treating it like income right now. It is just a button on a computer program.

Also, rather than accepting that this is no big deal, who is looking at this to make changes that are beneficial? Who came up with the prior prior year that is happening in a few months?

There are lots of things that are unfair in taxes. My employer matched 10%, vested immediately. I could withdraw that money immediately, (with a penalty but it was free to me, so who cares if I have to pay a penalty?). I’m happy that the FAFSA formula doesn’t require that I do that and all that retirement money is ‘protected’ no matter if I contributed it or if an employer did. Pension people don’t have that ability as it is not their money until they retire.

Just like with free parking and employer paid health insurance and subsidized day care and a gym membership, one has to consider all the benefits to taking a job, including tax benefits, when accepting a position at a certain salary. Many teachers accept positions with lower pay but better benefits, like an employer paid pension. The teachers at our school made very little but had really good health care benefits and a pretty good retirement plan (private school). Many people work at universities to get tuition benefits. A free, non taxed (usually) non FAFSA considered benefit.

You have the option of not contributing to the 401k now, or contributing with after tax dollars, paying the taxes on the income, and thus having FAFSA consider the true amount you have available for college now (in your example, the $40k-$13k). You have to actually PAY those taxes to get the credit.

Teachers in my area make more than many other professionals well into 6 figures! Never mind principals and school administrators who make even more. This is not a rant on teachers. I have a lot of respect for people that can stand in front of other people for 7 hours a day and come up with things to say, I could not. I doubt teachers at 25 think about the financial aid their children will receive in 25 years!

Simply that there is a significant portion of the population that still has a traditional pension and the portion that does not is disadvantaged both in comparison and by a formula that incorrectly makes the entire amount of the contribution factored in for FA calculation.

To digress into gym memberships misses the point. This is not nitpicking about why I do not get my pencils reimbursed and the person down the street does. The bottom line is this is a federal form, there is a FEDERAL public policy in making sure our elderly are not starving and many who did not save enough will be. All I am suggesting is that this form needs to account for the fact that not all of this money would EVER have been available.

I have a similar problem with investments as opposed to cash. If you have an investment with no basis in it (so you will pay tax on any profits from the first dollar). If you have 10k in cash, that is your cash that you can spend however you care to, you do not owe tax on it (except possibly for a tiny amount of interest). If you have 10k in investments that you have held for a long time your net is only 7k. So when asked for the value of your assets, you are still dinged at 10k instead of 7k even though that is all that is available for you to spend on education or anything else. It would be another simple fix in the calculator. Can you net out taxes when calculating the value of investments? I wonder

Keep in mind that teachers typically do not contribute to or benefit from Social Security. However they typically do contribute (mandatory) to their pension. In my state, teachers are required to contribute more than 10% of their income to mandatory pension contributions. Those who have worked other jobs that did require social security contributions will likely never see any return, as there is a windfall provision that limits or eliminates SS in that situation.

The simple answer is that there is no simple answer, because all schools calculate FA differently. I asked this same question to several different FA officers at the information sessions at schools we visited, often as I had to wait while my DH and our pups went on the campus tours. Some of the FA officers could not comprehend the questions, and asked that I email them, which I did, and even then the responses were sometimes inadequate, making me think they did not understand what we’re asking.

But overall, what became clear to me is that every school’s formula is different. Several schools do not add back in any 401K contributions when they figure available income. Other schools do consider that if you cut back on your contributions it will affect your tax bill, so it is not all available, but some don’t. What seemed most common to me was that schools seem to allow you to contribute up to 6%, as that is the most commonly matched amount. But again, it varies quite a bit. Some schools are keen to look for changes in your savings pattern - which is why they don’t want to see you’ve been contributing 15% this year but last year only 6%, to them that might not seem to fairly represent your whole picture. Not to suggest that retirement savings is a bad idea, they would usually just want an explanation.

The important thing to remember is that schools usually don’t expect that every additional dollar you earn will be available towards college costs, especially in situations where your income fluctuates. Their approach is that they want to treat all students fairly, and spread their resources around to the extent they are available.

It also seems evident to me that schools that are “harsh” on one aspect like retirement contributions, may not be so tough on other areas - like home equity. So it really is important to have the conversations with the schools so that you understand what you are facing, especially when income can change.

I hadn’t picked up on the asset/investment question until I had visited a few schools, and I heard another parent ask it - then I heard another ask it at a second school. What I learned was that while you cannot net out taxes from the value of investments, it is also fair to describe the problem in the supplemental information section, and the FA officers generally will understand. Their thinking is that if this asset has been saved for a long time for school and it comes time to liquidate it, they expect you will do so, and use the net proceeds to fund the expense. The school FA officers really do want to work with families to make sure they are being treated fairly.

When I realized that the investment question you raised was one that was commonly being asked by parents of HS sophomores and juniors, based on the answers being given, it made me realize that for some families with that type of investment, they may be better off liquidating it in the year before they apply to school, taking the tax hit and reducing available income, but maximizing their ability to get financial aid. At the very least, they should take the tax hit while it can still help them - if they wait until the student’s last year of college to liquidate that investment, they will have been assessed at the higher amount for all of the years that affected the FA calculations.

But practically, it seems that most families don’t have saved nearly enough for their pups - especially ours - but we were fortunate that our pups got accepted into CSS profile schools that had generous FA, so we’ve been able to make it work.

You got $13k tax free and want colleges to credit you with an additional $13k? I don’t see why they would do that.

If you’re putting away $40k/year and reduce that by $10-15k/year for however many years it takes to put your kids through college, you’ll hardly be poverty stricken when you’re 80. Colleges aren’t subsidizing the retirement of government employees, their employers are. If colleges start subsidizing the retirement of nongovernment employees, it would only be fair if they subsidized the retirement of government employees too. However, I don’t think fairness is the motivation behind college financial aid policies.

I suppose to colleges the difference is available assets. If you gross $100k, you have access to $100k. A government employee who earns $100k and who will have a government pension when they retire also has access to just that $100k. The pension is an employee benefit. Why should colleges make up for a company’s failure to offer traditional pensions? People who want those need to pursue the jobs that offer them.

Yes. No one said life is fair.

I am a retired teacher. I was required to pay 6% of my salary to the regular pension account every year I worked…no choice. In addition I paid 1 1/2% of my salary required to support retiree supplemental health insurance (despite what people think…all teachers do NOT have health insurance for life…we have Medicare and a supplement just like everyone else).

In addition, I live in a state where teachers do not contribute to social security and any SS earnings are reduced by 2/3 if one happens to have accumulated them elsewhere. So, I also contributed to a 403b account every year starting when I was 30.

And yes, when my kids went to college the contributions from the tax year were added back in as incime for financial aid purposes.

Honestly, I have no problem with this. None.

Gee, where do you live? I know a lot of teachers making 40k with no raises in years who would love to move there.

Not going to say but it is in a suburb with well rated schools but not legendary ones. A teacher in her 40s or 50s could easily make that.

@3puppies I am so happy to hear that I am not the only one to have thought of these things.

Your point about

illustrates why it is so important to know your financial situation and to the extent your kid has no preference, steer them to the school that provides the best financial option given YOUR situation. Good home equity will help one person but not another who rents or just bought. OTOH a school that treats 401K contributions well may help a family in their 50s for whom saving $6000 a year will not fund retirement, especially if they will still be paying for college at 65.