While most parents understand that it is never too early to plan for their child’s college education, many don’t realize that prepping for the FAFSA is included in that process, particularly for those whose children are in their sophomore or junior year.
Did you know that the tax information that needs to be included on the FAFSA isn’t from the same year as when you submit these critical college financial aid documents? This is critical for parents.
For example, if your child was going to college in the fall of 2018, the information used on their FAFSA is based on the 2016 tax year.
So, what does this mean for you? That you need to start prepping for the FAFSA well before your child will actually fill one out. Here’s what you need to know.
Your Tax Decisions Matter
Any tax decisions that occur during the tax year that ends in December during your child’s junior year will affect their FAFSA results.
That means some of your student’s financial aid offerings for their freshman year in college are impacted by your decisions made during their spring semester of their sophomore year and fall semester of their junior year.
Now, there’s no reason to be intimidated by this prospect. Instead, it simply means that preparing now is a smart move, and that begins with a solid understanding of how your tax decisions matter when it comes to your child’s FAFSA, particularly since they play a substantial role in determining your student’s expected family contribution (EFC).
Your EFC on the FAFSA
The Expected Family Contribute (EFC) is a dollar amount that is calculated after your student completes their FAFSA. It’s a reflection of what the system believes your family can afford and is used to determine your child’s eligibility for a variety of financial aid products, like grants and loans.
An EFC is determined based on data from four key areas: parental income and assets (with some exceptions below), and student income and assets.
Effectively, each area is used for one calculation on the FAFSA, and then the four results are reviewed together to make a determination.
By structuring certain portions of your financial life based on these points, you can make decisions that will help maximize the amount of need-based aid your child may be able to access based on their FAFSA results, lowering the need for alternatives, like student loans, that result in debt.
If you want in-depth information on the EFC calculation, the US Department of Education’s Federal Student Aid Office has you covered. You can review the information here: The EFC Formula
Not sure if you should submit the FAFSA? Here’s a helpful article explaining Why You Need to Submit FAFSA (& What to Do if You Missed the FAFSA Deadline)
Getting the Most Financial Aid through the FAFSA
While it may seem as though you have little control regarding how these calculations unfold, the opposite is actually true.
There are strategies that allow you to maximize the FAFSA results, making it easier for your student to receive need-based awards.
Please note: We are not financial advisors and recommend running these by your certified financial planner, CPA or another financial expert for verification.
Here are a few suggestions to get you started.
Avoid Withdrawing from Retirement Funds
Distributions from Traditional IRAs and 401Ks are treated as taxable income by the FAFSA, which means your EFC will increase and your student’s eligibility for aid will decrease.
If you must use your retirement savings for any purpose, look into loans that are backed by your retirement account instead. Loans are not treated as income, so it won’t impact the FAFSA. Or you can make the withdrawal prior to the year that will be used for their FAFSA.
As a note, Roth IRAs distributions are treated differently on the FAFSA, so the above rules don’t apply.
Maximize Your Retirement Savings
Home equity, retirement savings, and even some small businesses are typically excluded when it comes to FAFSA.
This means that traditional IRA and 401K contributions reduce the amount of income that is included in the FAFSA calculation, making it easier to get need-based aid. They are also tax-deductible, so maxing out your savings before the end of the tax year (December of your child’s sophomore year) can be beneficial.
Transfer Your Child’s Savings to Your Accounts
Did you know that the FAFSA assesses your student’s assets at a higher rate than yours? Many parents don’t realize this, and the rate difference is substantial. This means that transferring your child’s savings into your account before their second semester of their junior year can result in a lower EFC, so it can be a wise move. If the money won’t be needed until later, some parents put the cash into a CD under their own name.
Use Savings to Pay Down Debt
While having money in the bank is generally considered a good thing, it actually hurts your child when it comes time to file their FAFSA. While you don’t want to throw money out the window or spend it recklessly, if you have debt, then using your savings to pay it down can be beneficial for two reasons. First, you reduce your debt load, letting you pay less interest over time. Second, it means the cash won’t play a role in determining your child’s EFC (typically increasing it).
Typically, you will first want to make sure that any savings you use is earning less interest in that account than you are paying on the debts you will pay down as this ensures you are getting the most value from the decision.
Open a 529 College Savings Plan
Another option for lowering your EFC is to transfer some savings (yours or your child’s) into a 529 college savings plan. All assets in a 529 are calculated at the parental asset rate, and any distributions do not affect your child’s eligibility for financial aid.
This money can also be withdrawn penalty-free for non-education related expenses IF your child receives scholarship dollars to replace that income. Don’t believe me? Here’s a statement straight from the
If you and your child want to find scholarships to help pay for college, join our free 1-hour training where we cover exactly where to find external scholarships that qualify for this exception AND can be used at most accredited universities. Grab your spot to the next training at www.thescholarshipsystem.com/freewebinarpst.
Make Major Cash Purchases Before Filing the FAFSA
If you have a major cash purchase on the horizon, complete it before your child completes their FAFSA. Again, this helps lower the amount of any savings you have, ensuring the funds aren’t part of the EFC calculation.
If the cash purchase is for your student’s education, and they have savings that can’t be transferred to your account, then consider having them spend their money first, since their assets are calculated at a higher rate.
Don’t Limit Your Household to One College Student at a Time
While the idea of two (or more) family members being in college simultaneously may seem intimidating, it actually helps when it comes time to file a FAFSA.
Why? Because the EFC applies to your entire family, not just the individual student. For example, if your EFC is $20,000 and you have two children in college, then half of that amount (or $10,000 a piece) is typically associated with each student in the eyes of school. That means both of your children may cumulatively receive more in their financial aid packages than one of them would get if they are the only college student.
And, the two students don’t have to be siblings to fall under one EFC on the FAFSA! For example, if you went to college at the same time as your child, that counts too. So, if you were thinking of heading to school, it could be a great time to take the leap.
EFCs Change Every Year
It’s important to note that your child’s EFC will change every year based on their latest FAFSA information, so changes to income or savings levels can impact their financial aid throughout their college career.
That means, not only is it important to start planning for their first FAFSA, but it’s also important to make wise choices all the way through their final FAFSA filing. That way, your EFC can stay as low as possible, and you can help increase your child’s odds of graduating debt free.
For more quick tips to maximize the FAFSA, check out this article: New FAFSA Changes: 5 Quick Tips to Maximize Financial Aid