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How do retirement funds affect student aid eligibility?

Mark Kantrowitz

October 06, 2009

How do parent contributions to 401(k) or IRA retirement plans affect financial aid eligibility? — Stephen C.

The federal need analysis methodology considers both income (taxable and untaxed) and assets that are reported on the Free Application for Federal Student Aid (FAFSA).

Money in qualified retirement plans, such as a 401(k), 403(b), IRA, pension, SEP, SIMPLE, Keogh and certain annuities, is not reported as an asset on the FAFSA.

However, voluntary contributions from the taxpayer to these retirement plans during the base year (the prior tax year) are reported on the FAFSA and are counted as untaxed income. Employer matching contributions are not reported on the FAFSA. Untaxed income and benefits have a similar impact on aid eligibility as taxable income.

Non-elective contributions, such as mandatory teacher contributions to a state retirement system, are not reported on the FAFSA and are not considered in need analysis.

What happens when you have all your retirement in savings accounts? Will FAFSA take that into consideration when determining financial aid? — Stacey C.

Money in non-qualified retirement accounts, such as a savings or regular brokerage account or stuffed under your mattress, should be reported on the FAFSA as an asset. This is the case even if you are already retired and will be using all of your assets to pay for your retirement.

The federal need analysis formula shelters assets in qualified retirement plans, the net worth of the family’s principal place of residence and small businesses owned and controled by the family. There is also a simplified needs test that excludes consideration of all assets for families where the parents’ income (dependent students) or student’s income (independent students) is less than $50,000 and certain other criteria are met. For all other assets there is an age-based asset protection allowance that shelters some of the remaining assets based on the age of the older parent. For age 65 and up in 2009-10 this allowance is $84,000.

If you receive a lump-sum distribution from a qualified retirement plan, it is best to roll it over into an IRA or other qualified plan in order to shelter it from need analysis.

Does the FAFSA have some mechanism where parents ages are identified and considered? It seems unfair for parents who will be in their early 60s when the child graduates to have the same expected family contribution as a parent in his or her late 40s who has 15 more years of earning potential. If not, would it be helpful or detrimental to politely point out to a financial aid office the burden that loan-only aid would place on a family who has little or no savings and where both parents will be retiring soon? — Leah G.

For a dependent student, the FAFSA asks for the parents’ date of birth. This is used to calculate the age of the older parent and to trigger the asset protection allowance. However, the impact on aid eligibility is relatively small. The asset protection allowance in 2009-10 for retired parents is $84,000 while the asset protection allowance for parents aged 48 (the median age of parents of college-age children) is $52,400. This leads to a difference in the expected family contribution of at most $1,782.

The Student Aid and Fiscal Responsibility Act of 2009, if enacted, will eliminate all six asset questions from the FAFSA. This would eliminate any penalty for saving, even if a family saves for retirement in non-qualified accounts.

College financial aid administrators do not have the authority to increase your aid eligibility because you are close to retirement. If you have high unreimbursed medical or disability related expenses, they can make an adjustment to income to compensate. But otherwise the age of the older parent does not represent an unusual circumstance that justifies a professional judgment adjustment.

You should not borrow a Parent PLUS loan if you believe that you will be unable to afford the monthly payments. (The new income-based repayment plan is not available for Parent PLUS loans.) The federal government may withhold up to 15% of your Social Security benefits if you default on your federal education loans. The US Supreme Court upheld the federal government’s ability to do this in Lockhart v US (04-881, December 2005).

That being said, the regulations at 34 CFR 682.201(a)(3) and 34 CFR 685.203(c)(1)(ii) and (iii) allow a college financial aid administrator to make a dependent student eligible for the higher unsubsidized Stafford loan limits available to independent students if “the student’s parent likely will be precluded by exceptional circumstances from borrowing under the Federal Direct PLUS Program or the Federal PLUS Program and the student’s family is otherwise unable to provide the student’s expected family contribution”. You could ask the school to make your child eligible for the increased unsubsidized Stafford loan limits because of your lack of savings and imminent transition to fixed income. Most colleges focus on more extreme circumstances, such as receipt of only public assistance or disability benefits or the incarceration or institutionalization of a parent. But it doesn’t hurt to ask. If all else fails, have the parent with the worst credit apply for the PLUS loan, since a PLUS loan denial will make your child eligible for the increased loan limits.


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