Understanding The Pros and Cons of Any College Financial Aid
by admin on Aug.07, 2009, under Financial Aid
If you are like the vast majority of American’s in our sagging economy, your family will be looking for additional funds to help cover the cost of a college education. The largest share of this need-based supplemental money comes from the federal government through its financial aid system.
But the government also assumes that you are able to participate in the expense of educating your child prior to considering how and to what level they will participate in funding your child’s education. Therefore, in order to determine your initial level of participation, families are required to fill out the Free Application for Federal Student Aid, or FAFSA form.
The FAFSA captures the required financial information used to calculate how much your family is expected to pay via a formula known as the Federal Methodology (FM). Your initial or beginning monetary participation level is known as your Expected Family Contribution (EFC).
The data used to generate the initial EFC calculation is collected beginning in January of your child’s junior year in high school and ends on December 31 of that same year, which would be his or her senior year in high school. This time frame is referred to as your “base year.”
In essence, if you’re in your base year, you are now under the financial aid microscope and any financial moves being considered (including the sale of real estate or stocks, withdrawals from IRAs, contributions to retirement plans, receiving monetary gifts, etc.) must be weighed not only from a federal tax standpoint but also in relation to the financial aid system. The catch is that what makes sense from a 1040 point of view may have adverse consequences on your chances of receiving financial aid.
Case in point: Consider contributions made to your 401(K) plan at work during your child’s base year or any year prior to financial aid application. In order to encourage individuals saving for retirement, the federal government does not tax contributions made to 401(K) plans up to a specified annual limit. This money enters the retirement plan on a pre-tax basis with taxes being accounted for as money is withdrawn to supplement retirement.
The Federal Methodology used to calculate your EFC treats these contributions from an entirely different prospective. The financial aid system believes that you can stop contributing towards retirement and apply these contributions to college expenses. They anticipate you playing “catch up” with these contributions after your child is out of school.
Accordingly, your pre-tax retirement contributions, which are not considered taxable 1040 income, are considered “untaxed income” by the financial aid system and are added back into the EFC calculation and assessed at the applicable rate.
Understanding the pros and cons of any financial moves made during your base year - or any year in which financial aid is applied for - from both a tax and financial aid standpoint goes a long way toward determining what you pay for college. The process is complicated and should only be done in consultation with a qualified professional.
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