<p>Yes, it is untaxed income because you get a tax break when you put the money into the 401K. But in most cases you will find that the hit on your EFC is outweighed by the tax advantage. That is, your AGI is reduced by $31K, so if you are in a 25% tax bracket, you save $7750 in taxes. </p>
<p>Your EFC would increased based on the “untaxed” money - that is, lets say that if you don’t put the money into the 401K, your EFC based on your income and other assets is $20K. You put the $30K in the bank instead, where it sits as an extra asset. As an asset, that $31K boosts your EFC by $1736-- (assets are “taxed” for EFC purposes at roughly 5.6%) – so now you have an EFC of $21,736.</p>
<p>If you put that money into the 401K instead, you still have the “base” EFC of $20K, but you don’t have the additional hit for savings. Instead, however, because this income was not taxed, it adds to your EFC by a maximum of 47% x $7750 (the amount of tax savings) - which is $3642, putting your EFC at $23,642. That’s an increase of $1906 over what it would be if you had put the money in the bank rather than the 401K. (Either way, the $31K counts toward your base EFC). </p>
<p>So assuming that your child’s college meets your EFC, the choice to put the money in the 401K means you have to pay slightly more than $1900 in tuition money – but you SAVED $7750 that you didn’t have to pay IRS. So your net benefit from putting the money into the 401K is $5584. So you need to reframe the question: is it a good idea to put $31K into your 401K if it will result in a net savings of $5584?</p>
<p>Now of course this assumed a 25% tax bracket – the higher the tax bracket, the more the potential savings (in reduced taxes)… BUT my analysis does not account for what happens if you have to pay Alternative Minimum taxes. (You’d have to redo the analysis).</p>
<p>It also is based on the assumption that the college meets your EFC with grant money. Given the size of your 401K contribution, I’m assuming your EFC is fairly high - that’s why I hypothesized a $20K “base” – but maybe your EFC is $35K or $40K. The higher the EFC, the greater the likelihood that the college financial aid consists mostly of loans. If so, there is no real benefit with a lower EFC-- it just means that the college encourages you to borrow more. </p>
<p>The other assumption is that the college will meet 100% of EFC. If the college does not make that commitment, there is no guarantee they will give you more money with a lower EFC. It may be that the college is going to give your kid a maximum of $8000 in grant money no matter how poor you are (NYU financial aid generally works like that, for example). If there is no guarantee of money… then a lower EFC is of no benefit whatsoever. </p>
<p>So bottom line: if you can afford it, its worthwhile to continue to fund your 401K to the extent that you get a tax benefit for it. But with your earnings, you probably are dreaming if you think you will get much in financial aid anyway, so you had better start by running that “base” EFC calculation. If your EFC is more than the COA (which is very likely the case if your kid attends a public college), then you won’t be getting money from the colleges.</p>
<p>And then you have to ask yourself whether you have $31K to spare to put into the 401K the same year you are trying to pay your kid’s college tuition.</p>