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Questions about retirement plan contributions and help for a student whose brother has cancer

Mark Kantrowitz

April 19, 2010

We are a family of 4 with gross income of about $58,000. With IRA and 401(k) contributions and pretax health care deductions our AGI is about $47,000. Would it benefit us as far as financial aid grants go to max out on our retirement accounts and knock our family AGI down to about $30,000 or less? Or do the aid people see the gross income of $58,000 and ignore the $30,000 AGI? Next fall one child enters college and one will still be at home. — Michael B.

The basic philosophy of need analysis is to assess a portion of discretionary income, which is calculated by subtracting non-discretionary expenses from total income. IRA and 401(k) contributions are considered voluntary and so will be added to adjusted gross income when calculating total income. Thus your IRA and 401(k) contributions will be counted, and maximizing your contributions will not reduce your expected family contribution. However, the pretax health care deductions, including any flexible spending arrangements (cafeteria plans), are ignored by the formula and so will increase aid eligibility.

There are two important thresholds on adjusted gross income in the need analysis formula, one at $50,000 and one at $30,000. Families that satisfy certain other criteria are eligible for the simplified needs test when their adjusted gross income is less than $50,000. The simplified needs test ignores assets. Families that satisfy certain other criteria are eligible for automatic zero EFC when their adjusted gross income is less than $30,000. As the name suggests, this sets the expected family contribution to zero, allowing the applicant to qualify for a full Pell Grant.

Your income is quite close to the $50,000 threshold. If you have significant assets other than the family home, retirement accounts, and a small business, it may be worthwhile to consider ways of reducing your adjusted gross income below the $50,000 threshold. The most common methods include realizing a capital loss of up to $3,000, maximizing cafeteria plans, and using the tuition and fees deduction and the student loan interest deduction. (However, the Hope Scholarship tax credit may offer a better financial benefit than the tuition and fees deduction, so you will have to evaluate the tradeoffs of using the tuition and fees deduction instead.)

The need analysis formulas are heavily weighted toward income, so reducing your adjusted gross income will also decrease your expected family contribution and increase eligibility for need-based financial aid.

Even though your retirement plan contributions do not affect your eligibility for need-based financial aid, you should continue contributing to your retirement plans. Contribute at least enough to maximize the employer match, if any, as that represents free money.


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