<p>My company just offered a <strong>Roth</strong> 401k. For those of you unfamiliar, this is different than a traditional 401k; instead of sheltering the income now, you pay tax now, but, like a Roth IRA, you pay no tax when you take it out.</p>
<p>So I figure I'll dust off the EFC calculation spreadsheet (I made it from the FAFSA pdf forms), update the values from the current pdf, and see how much <em>worse</em> it would be if I put the money in the Roth 401k versus what I do now, the traditional 401k.</p>
<p>But my EFC went DOWN! My 'real' 2011 tax forms have the traditional 401k. I opened up the tax software, altered the W2 (just moved the $ from box 12 D to box 1). Then I took the values from that "what if" form and plugged them into the EFC calculations, and my EFC went down by 6%.</p>
<p>So the question is... has anyone else done this exercise and determined something simliar, or different?</p>
<p>When you pay into a traditional 401k, the money is taken out of your income pre-tax. This lowers your Federal and possibly your State Income Tax.</p>
<p>When you pay into a Roth 401k, the money is taken out after tax.</p>
<p>For FAFSA, the contribution to either kind of 401k is added back into your income. The actual Federal tax due is used as an allowance against income. This means that you have a larger allowance for Federal taxes if you have a Roth 401k because you pay more Federal Income Tax, which will result in a somewhat lower EFC.</p>
<p>Our EFC went up a bit this year because we pay fewer taxes than originally estimated because we were able to claim the American Opportunity Credit for Happykid’s expenses. However, the overall financial picture leaves us ahead.</p>
<p>And, the most important thing to remember about the EFC, is that unless you are in Pell territory, or your kid lucks onto a college/university that guarantees to meet full need based only on the FAFSA, your actual EFC is meaningless. Most places will expect you to shell out more (often much, much more) than your EFC.</p>
<p>Your EFC will be lower by as much as 47% of the amount of extra tax you pay when using a Roth 401k vs. a regular 401k.</p>
<p>But with a Roth, 100% of the money used to pay the taxes is unavailable to pay college costs.</p>
<p>As happymom said, for most schools lowering your EFC will not get you anything but more loans.</p>
<p>So would you rather have the extra money saved on taxes with a regular 401k that could be used to pay college expenses? Or take a chance on getting a small amount extra (and most likely zero) in FA?</p>
<p>I take the cash saved from not paying the taxes, but you have to evaluate what is best for your current situation and future retirement.</p>
<p>Thanks all for the thoughtful replies. The math is making sense to me now…all those extra taxes I’m paying make me poorer.
This will be FAFSA number 3 for me. The school said they had the option to use IM or FM. In my case, the IM EFC is much lower. The FAO keeps talking about that my EFC is right at the federal level. And the loans so far have been fixed. But I guess you’re right that there’s no guarantee they’ll up the discount. This will be especially interesting when daughter 2 goes to school (I have a 1 year overlap, presuming daughter 1 gets out in 4 years).</p>
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That’s not a concern in my case because 100% of the college costs are delivered from a 529 account.</p>
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Probably the biggest factors for me on this question surrounds whether I’ll be paying higher tax rates in retirement. But that’s the traditional IRA/Roth question (non-FA). I’m relieved that the option to go into a Roth 401k instead of a traditional 401k will not impact my financial aid “the wrong way”; that makes for a ‘clean’ Roth decision. I think they will give me the additional discount, based on my discussions so far with the FAO.</p>
<p>What will really be wonderful is when I’m out of this FA world all together. Then I can make financial decisions based on the tax code, and the investment’s parameters, without having to factor-in the hit on FA.</p>
<p>This probably does not apply to the OP - but one other consideration may be the AOC credit. If your income is near the cutoff for the AOC it may be better to do the traditional 401(k) since that contribution is subtracted from your income before eligibility for AOC is determined. I was considering not putting money into my 401(k) this year while 2 are in college - then I realized I would lose the AOC ($5k for 2), reduced income tax and the company match. Granted the AOC is due to expire this year - but since I am near the income cut off it makes sense to keep the 401(k contributions this year.</p>
<p>It could apply, well, probably could apply to a lot of folks making this decision. If they qualify for FA, then probably low enough income to be able to take advantage of the AOC. In my quick analysis, I went into HR TaxCut and moved the 401(k) money to regular income, the software allowed the AOC credit to stay. I even went through that bit of interview just now and it stayed. So in my case, it didn’t matter, but for someone who makes more money (we file jointly and DW doesn’t work outside the home), it might have dried up on them. Good point. </p>