College Corner: Retirement Contributions and Need-based Financial Aid
This is the first of a monthly blog which we refer to as “College Corner”. Our intent here is to provide answers to your college planning questions and help you determine your best strategy to save and pay for college.
With some four-year private universities now costing over $265,000 the need to plan and explore all of your options has never been more important.
Our college planning goal is to help you think outside the box. It goes well beyond just taking out student loans or opening a 529 account.
We believe that every college plan should address selection, financial aid, tax aid and the best use of your personal resources.
Being proactive and having a plan will not only help your children get in the best school at the best price but also help protect and grow your retirement.
With that let’s field our first question. We hope this helps!
Can I increase my financial aid eligibility by contributing to a retirement plan?
We get this question quite often. The answer is generally no. Employee contributions to retirement plans such as a 401(k) or IRA get added back to your adjusted gross income when calculating your expected family contribution, or “EFC”. Your EFC is the minimum amount you are expected to contribute towards the cost of college each year. The formula for determining need-based eligibility is (Cost of attendance – EFC = Need). So by reducing your EFC you can potentially make yourself eligible to receive more financial aid.
The reason why colleges make you add retirement contributions back to your income is because the money would have been eligible for college expenses if not contributed. Colleges expect parents to contribute up to 47% of their income, after modest allowances, towards the cost of college. So you can see why it can be beneficial for families to try and find ways to reduce reportable income.
Employer contributions to retirement plans are treated much differently and favorably for aid purposes. They are not added back to income when assessing eligibility for need-based aid. This includes company matching contributions and pension contributions. One potential planning strategy for C Corp. business owners would be to establish a pension plan, such as a cash balance plan. Contributions to such plans will reduce taxable income, fund goals such as retirement and potentially help your child qualify for more need-based aid. This strategy can be highly effective when applying to most elite private schools where they will meet the majority of a student’s need with grants and scholarships.
College planning doesn’t happen in a vacuum. You need to consider all factors when developing your strategy. Making retirement contributions by themselves is generally sound planning considering the tax and future income benefits. Some families can also benefit by receiving thousands of dollars in additional need-based aid. You should explore your options and ask your advisor if this strategy is right for you.