<p>Our income increased $5000 this year. We're in the 75K to 90K bracket jointly. But last year we put $7000 in a regular IRA which decreased our AGI. SO the AGI difference will be $12,000. I've heard from some NOT to decrease our income with an IRA contribution. Instead, if we decide to contribute to IRA, make it a Roth. We also have the full Amer Opp Grant amount of $2500. DS will be a sophomore next year. Much of his aid is in income based grants (pricey private school.)</p>
<p>I know taxes are tricky and every case different, but can anyone advise on this IRA thing?</p>
<p>Thanks!</p>
<p>PS. We are also OLD...60ish. ;)</p>
<p>The way FAFSA and most PROFILE formulas work, your AGI is reduced by the taxes you owe on your income. So if your taxes are reduced, then you don’t get as much taken off that AGI. Because any contribution to an IRA, HSA, 401K or other plan that reduces your taxable AGI does NOT reduce your FAFSA or PROFILE AGI (those contributions are added right back to AGI for a financial aid AGI that will not match your taxable income figure), if you run the figures through the financial aid formulas, you get the very same income figures whether you contribute to ROTH or regular IRA initially but then when you subtract out the taxes, you will be have less smaller net AGI with the ROTH since you pay less taxes with an IRA. </p>
<p>So you need to weigh what the advantages are. If your marginal tax rate, state and federal is 33%, a $7K IRA contributions means that you pay $2333 less in taxes. However your income for financial aid purposes is $2333 more. What is the marginal rate that this $2333 is going to be hit for fin aid purposes? At 50% we are seeing a decrease in $1166 in aid. You still make out net by $1166. You lose out $1166 in aid, but you pay $2333 less in taxes. You have to do the math.</p>
<p>Normal rule of thumb these days seems to lean towards Roth IRA’s over the Traditional version. However, in your situation this may not be true. Of course if you go the Traditional route, you will reduce your federal (and probably state) tax bite up front. The question then becomes how much additional aid will your DS receive with $7K less AGI?</p>
<p>Can this $ figure be estimated? Without running all the numbers, on the face of it, it looks like you may be better off by taking another Traditional IRA deduction this year…just guessing that the increase in financial aid will more than offset the whole “tax-deferred” vs “tax-free” argument.</p>
<p>You might want to ask a financial aid officer what the marginal bite is at your income level in their fin aid formula. It would help if they would give you that percentage. If it’s a school that doesn’t guarantee to meet full need, and operates on using the prior year aid to determine the next, it can make a difference too, if there is a good chance a dip in pay is coming. </p>
<p>Thanks everyone. If I get another snow day and have time, I might try to calculate FAFSA with both. </p>
<p>Outside of the financial aid consideration, the difference between a Roth IRA and a conventional IRA boils down to this: do you want to pay taxes on the money now, when you stash it away, or later, when you need it in retirement? If you think that your tax rate will be higher in retirement, than pay the taxes now (Roth IRA). If you think that your tax rate will be lower in retirement, than take the deduction now and pay the taxes later (conventional IRA). Also, with a Roth IRA, the earnings are tax free (for qualified distributions). With a conventional IRA, the earnings are only tax deferred.</p>
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None. Reducing your AGI with a traditional IRA contribution does not reduce the income used to calculate your EFC. Any pre tax income contributed to a retirement account in the tax year reported on FAFSA is added back to income in the EFC formula. </p>
<p>Taxes are an allowance against income in the EFC formula, so yes reducing your taxes will probably increase your EFC a little. However you will likely save more in tax than it will add to your EFC. The maximum % of income that can go to the EFC is 47%. So if you save say $2000 in taxes, the max impact it will have on the FAFSA EFC is $940. So you are $1060 ahead.</p>
<p>However, I would make your decision on whether to go for a Roth or a traditional based on other criteria - i.e. which do you think more beneficial to you - the tax break now or the future potential tax free earnings. </p>
<p>Thanks, Swimcatmom. I knew the untaxed income, like IRAs, was just added back to our income, but I didn’t know if it counted the same way as regular income. Probably won’t matter much either way. </p>