[Edited 06/08/2019 to clarify that only pre-tax retirement account contributions are added back to income]
[Edited 06/08/2019 to correct the mistake that children reach independence at 24 under the eyes of FAFSA, not 26]
[Edited 06/08/2019 to link back to section of a previous post on gapping]
[Edited 05/30/2019 to change takeaway of rental real estate equity to state there is no change to your EFC by making extra principal payments to non primary residence mortgages]
[Edited 05/30/2019 to add section explaining children should transfer all non retirement savings to their parents]
[Edited 05/05/2019 to add sections explaining income can't be shielded, and that neither the source of the income nor the source of included assets affects the rates at which they're assessed]
[Edited 05/05/2019 to fix an error in the rate at which student assets are assessed for FAFSA. In one location it was correctly stated as 20% and in another it was incorrectly stated as 50%]
[Edited 05/05/2019 to clarify language about retirement account contributions being added back to income]

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.

Also, my assumed audience is a parent with a dependent child going to college (FAFSA defines independent children as being over the age of 24, married, or a couple other exceptions).

Some Schools Won't Meet Your Need

See the section in my previous post on gapping.

Income Can't be Shielded

There is no way to shield income from the FAFSA. In fact, there are several untaxed sources of income, such as Roth retirement account withdrawals, that are added to income for FAFSA purposes.

All Income is Treated the Same

In other words, the source of the income doesn't matter; it all gets assessed towards your EFC in the exact same way.

All Assets that are Considered are Treated the Same

While some assets are excluded from FAFSA, of those that are included, are assets sources are assesed towards your EFC in the exact same way.

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]

(Non) actionable takeaway: There is no change to your EFC by mkaing extra payments towards the principal of your non primary residence 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, but are flat rate. 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.

Kids Should Give All Non-Retirement Savings to their Parents

This should be an actionable takeaway for the previous section, but this is important enough to merit its own section: so long as there is trust between the kid and the parent, the kid should not hold any non-retirement savings and should instead transfer all such savings to their parents. All assets held by the child are assessed at 20% towards the EFC, whereas all assets held by the parent are assessed at 5.64%. Even if the child does not intend on using the money to pay for college, by holding the money themselves they are increasing their EFC. Once they graduate, it is a simple matter of the parents returning any remaining money, if applicable.[6]

As far as I understand it, this transfer of savings only needs to be done once a year, before filing the FAFSA. You do not report the average balance of your savings over the previous year; just the current balance at the time you file the FAFSA.

Pre-Tax Retirement Account Contributions Are Added Back to Income[7]

While pre-tax (traditional) retirement account contributions reduce the income reported on your tax forms, they do not reduce the income reported on FAFSA. 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: You should still 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. Simply moving this money back and forth will probably constitute a gift, subjecting yourself to filing a gift tax return. However, in general, you won't end up paying gift taxes, though you will have to file gift tax returns if you exceed the gift tax exclusion limit - $15,000 in 2019. Also, if the child's money is just given to the parents for safekeeping during their college years, and not actually spent on college tuition, then one could probably structure this as a loan - which would require a written contract - so as not to have this classified as a gift. But I am not a lawyer nor accountant, so I don't know if this will work ↩︎

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