/ FAFSA

General Gudelines for FAFSA

While my previous post on the Free Application for Federal Student Aid (FAFSA) was focused on the simplified and automatic zero Expected Family Contribution (EFC), today I'll be focusing on more general guidelines. I will be using the FAFSA for the 2018-2019 school year. Note: as in the name, the EFC is the amount the government expects you to pay for college. To maximize aid you want to minimize this number.

Many of these actionable takeaways are a reason in the pro column for one of two options. However, it doesn't necessarily mean one option is better than the other; you can end up increasing your financial aid while also increasing your tax liability and/or decreasing your investment profits. Ideally the magnitude of both effects would be calculated.

Retirement Accounts and Home Equity Don't Count Against You

Any money held in your retirement accounts (such as 401(k), 403(b), 457(b), 401(a), and IRA accounts), and the equity in your primary residence, are not counted towards your EFC [1].

Actionable takeaways:

  • If you are contemplating making extra payments towards the principal of your mortgage vs investing that money in a taxable brokerage account, this is one reason in favor of paying the principal of your mortgage. If you're contemplating the mortgage vs a retirement account, this makes no difference.
  • If for whatever reason you were contemplating investing in your retirement account vs your taxable brokerage account or bank account (though I would contend you should, in essentially all cases, max out your retirement account first), this would be a reason in favor of investing in your retirement account.

Rental Equity Does Count [2]

Actionable Takeaway: This is one reason in favor of not making extra payments towards the principal of your real estate mortgages.

The 2 Year Delay and Grandparents 529s

While assets in the parents' names (assuming a dependent student) and the student's name are reported on FAFSA forms, assets in other relatives' names are not reported [3]. Of particular importance to us is that the asset value of 529s in grandparents' names are not reported on FAFSA forms. However, withdrawals from non relatives' 529s do count as untaxed income for the purposes of FAFSA[4]

There is a 2 year delay between realizing income and having it affect FAFSA. Specifically, for the 2018-2019 school year, income from 2016 is what is reported on the FAFSA. This includes untaxed sources of income, such as withdrawals from relatives' 529s.

Actionable takeaway: See if a grandparent is willing to open a 529 for your student and use that in the third calendar year of school (so for a student starting in Fall 2018, start using grandparents 529s in 2020, because in the student's senior year of 2021-2022, 2019 income is reported). The ideal case is if the parent has no 529s in lieu of the grandparent having them.

Note: This can work with any other relative like aunts and uncles, but it's most common to find grandparents willing to pitch in for college costs.

Student Assets and Income are Assessed at a Much Higher Rate than Parental Assets

After filling out the long FAFSA form, there is another form to calculate the EFC. As I discussed previously, parental assets and income are assessed on a progressive scale, with the top rates being 5.64% and 47%, respectively. However, the rates for student assets and income are 20% and 50%, respectively. Furthermore, the rates for student assets and income are not done on a progressive scale. They are flat rate. Student assets have no allowances; all assets are assessed at 50%. Student income has allowances (that is, an amount that can be excluded from income) for income and Social Security taxes paid, plus and additional $6420. That is, if a student earned $8000 and paid $500 in income and Social Security taxes[5], the first $6920 ($6420 + $500) of income is not assessed, and the remaining $1080 is assessed at 50%.

Actionable takeaway: Don't gift your kids money if you want them to get financial aid. On the other hand, paying them money (at market rates) by hiring them for a business you own will not affect financial aid so long as your kid contributes that money to an IRA (or other retirement account).

Retirement Account Contributions Are Added Back to Income[6]

But remember, the asset value of these accounts doesn't get assessed for FAFSA. If you saved this in a taxable brokerage or bank account, you'd be assessed again for the asset value.

Actionable takeaway: Use your retirement accounts

SEPP Looks Slightly Better in Light of FAFSA

There are two common ways to get money out of retirement accounts penalty free before the age of 59.5: the Roth conversion pipeline and the SEPP.

The Roth conversion pipeline involves converting money from your traditional IRA to your Roth IRA each year. In each year you do a conversion, you pay taxes on the converted amount. You can withdraw the converted amount 5 years later from your Roth IRA—that is, in year 6, you can withdraw year 1's conversion, in year 7 you can withdraw year 2's conversion, etc.
This plan requires 5 years of expenses to be saved outside of retirement accounts while you're waiting for the pipeline to get started.

Substantially Equal Periodic Payments (SEPP), otherwise known as 72(t), essentially annuitizies your IRA, and lets you withdraw money from your IRA penalty free according to one of three formulas. The disadvantage to the SEPP is that it is inflexible: you must pick a formula from the start and follow it to the letter until you reach 59.5. If at any point you withdraw the incorrect amount, you are liable for penalties on ALL previous withdrawals.

Actionable takeaway: If you planned on using the Roth conversion pipeline and the 5 year period of starting it coincides with your kid(s) going to college, then you may want to take a second look at the SEPP. The 5 years worth of living expenses outside retirement accounts will count against you for FAFSA.


  1. Paragraph 5 in notes for questions 42, 43, 91, and 92, page 9 of the 2018-2019 FAFSA ↩︎

  2. Paragraph 2 of notes for questions 42, 43, 91 and 92, page 9 of the 2018-2019 FAFSA ↩︎

  3. There is no section for other relatives to report their assets on the FAFSA form ↩︎

  4. Paragraph 4 of notes for questions 42, 43, 91 and 92, page 9 of the 2018-2019 FAFSA ↩︎

  5. I did not actually check if $8000 in income results in $500 in taxes. I just picked these numbers for simplicity ↩︎

  6. Line 45a of 2018-2019 FAFSA form ↩︎

General Gudelines for FAFSA
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