Are you one of the millions of parents with a child headed to college, either now or in the future? It may come as a surprise that saving for your own retirement could help you pay for college. How’s that for good news?
The Free Application for Federal Student Aid (FAFSA) is the standard form used to determine the level of federal financial aid your child will receive. Your income and assets, and your child’s income and assets, are run through a formula to calculate the amount of aid available to you. And here’s where putting money into your own IRA or employer retirement plan can help: retirement accounts don’t count.
Karen Chan, Certified Financial Planner and educator with University of Illinois Extension offers this example: “If you have $5,000 in a bank savings account, you include that as an asset on the FAFSA form. And you could be expected to use 5 to 6% of that for your child’s education each year. Over four years, that could cost you more than $1000 of your savings. But if the $5,000 is in an IRA or your retirement plan at work, it doesn’t show up in the calculations and you get to keep the whole $5000.”
Not all families qualify for financial aid, so this might not apply to you. And parents whose income and assets are very limited will qualify for the maximum amount of aid without reducing their countable assets any further. But for those in the middle, this is just one more reason to fully fund your IRA or 401(k).
If you’re afraid that you’ll actually need that money to pay for your child’s college, you can hedge your bet by putting the money into an IRA. Distributions from IRAs used to pay for qualified higher education expenses (including tuition and fees, books, and even room and board if the student is enrolled at least half time) get special treatment. You will owe income tax if you take a distribution. But you avoid the 10% penalty that applies if you’re not yet age 59½, because you’re using the money for higher education expenses. “Just wait until after you’ve filed the FAFSA for the last year of college before you take that distribution,” advises Chan, “since you will report it as income on your 1040. That additional income could reduce the aid your child receives.”
And what if it’s a Roth IRA? Distributions from Roths that are used for qualified higher education expenses also avoid the 10% penalty. And, distributions from Roth IRAs are treated as coming first from contributions. You already paid the tax on the contributions to a Roth, so you’ll owe no tax until you’ve withdrawn all your contributions and start taking out the earnings.
If you’ve saved enough money elsewhere to take care of your own retirement, you might consider your IRAs as a source of funds to help your child with college expenses.
You can get the details on this and other aspects of retirement planning at University of Illinois Extension’s award winning website, Plan Well, Retire Well: Your how to guide at www.RetireWell.uiuc.edu. Click on the link for the fact sheet, Taking Distributions from Tax Deferred Retirement Plans, under the website section “Save for Retirement/Tax Deferred Plans.”
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Source: Karen Chan, Extension Educator, Consumer and Family Economics
Countryside Extension Center
University of Illinois Extension
(708-352-0109)
