Source: Mike Branch, The Huffington Post
With college expenses at some of the best schools now exceeding $60,000 per year, education-related expenses are often one of the biggest obstacles many baby boomers face when saving for their own retirement. For many families, planning for a college education goes hand in hand with IRA’s and retirement planning.
Retirement Assets are Exempt from the EFC
A family’s Expected Financial Contribution or EFC is determined by a Federal formula after submitting the Free Application for Federal Student Aid (FAFSA) form. Typically, this is done in the winter or spring of a student’s senior year of high school.
IRAs and other retirement accounts are exempt assets when calculating a family’s need for financial aid. A family can have $1,000,000 or more in an IRA or qualified retirement plan with no impact on their EFC.
To lower a family’s EFC and increase their potential to receive financial aid families should consider strategies to maximize contributions to their IRA, 401(k) and other retirement accounts. And they should fund those accounts before completing the FAFSA or other financial aid forms.
For example, a family with two 50-year old parents can put $6,500 into Roth IRAs for each parent and up to $23,000 each into their 401(k). A total of up to $59,000 in assets can be sheltered from the financial aid calculation in this way each year.
Employee contributions to retirement plans are factored into the family’s EFC; however, employer contributions are not. In the example above, the $23,000 employee contribution to the 401(k) gets added back into the financial aid calculation as non-taxed income. The benefit of this strategy is not that the income is lower for purposes of qualifying for additional financial aid, but that the assets are removed from the financial aid calculation. In the case of a family with significant assets, maximizing retirement plan contributions can help shelter at least some of those assets from the calculation of need on the FAFSA form allowing them to possibly qualify for additional financial aid.
Families may also benefit from the tax savings that come from making such a large retirement plan contribution. The tax savings can then be redirected towards college expenses. By contributing up to $46,000 ($23,000 from each parent) to their employer’s 401(k) plan, a family can reduce their tax bill significantly. The tax savings can be used to help cash flow a chunk of college expenses. This may be an effective strategy for some families who may be good candidates for need-based financial aid, but have significant non-retirement assets.