Generally, at the end of the year, I begin discussing delaying income or bonuses until the next year in order to lower your tax bill. Let me bring another reason to the table: Your income for the previous year is used when filling out the Free Application for Federal Student Aid (FAFSA).
The FAFSA is an annual form completed by current and prospective college students to determine their eligibility for student financial aid. Information on the FAFSA may be used to award grants or scholarships as well as to apply for federal student loans. Applying for financial aid is not simply applying for $100,000 to spend on higher education, but rather the U.S. Department of Education uses a completed FAFSA to calculate how much a student qualifies to borrow by determining how much the student’s family is able to contribute, known as the Expected Family Contribution.
Financial planning for the FAFSA can be tricky, as certain assets affect your student’s eligibility. To start, most financial aid is awarded on a first-come, first-serve basis; therefore, you want to complete your application as early as possible. For students seeking financial aid for Fall 2016, the application period opens Jan. 1, 2016. The application will require information from your 2015 federal tax return. If you have not completed your tax return, you can furnish an estimated return. However, you will need to provide the tax return when it is complete.
Not all assets are treated the same in the financial aid calculation. Assets in retirement accounts, such as IRAs, Roth IRAs, and 401(k)s, are not counted. While you can withdraw penalty-free assets from both a Traditional and Roth IRA for higher education, that withdrawal will be considered income on the FAFSA the following year. Equity in your primary residence is also not considered. Other assets that are not considered include the cash value of whole life insurance policies and a family business, provided the family owns more than 50% and the business has fewer than 100 employees.
Assets that will affect your Expected Family Contribution include secondary or vacation homes, brokerage accounts, mutual funds, bank accounts and cash. Up to 5.64% of parental assets are counted while custodial accounts or other liquid assets in the student’s name are counted at 20%. Assets in 529 Plans or Coverdell Education Savings Accounts are always counted; however, withdrawals that are used to pay for college are not considered income the following year. If the savings account is owned by a third-party, such as a grandparent, withdrawals from those accounts will count as income.
Some FAFSA advisers recommend using cash or liquid assets to pay down your mortgage or to purchase life insurance to essentially shelter your assets in investments that are not counted. However, before you make such financial moves, you should consult your financial adviser to be sure these investments will work for your situation.
While the thought of your child owing thousands of dollars in student loans may be daunting, it is important that you do not derail your own retirement to pay for your child’s education. There are no loans to fund your retirement.
If you have questions regarding how your assets may affect your child’s student aid eligibility, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
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