FAFSA Basics: What’s NOT Included

Sep 23

I spent the weekend dropping my daughter off at college and I’m still glowing from UChicago’s amazing orientation weekend for incoming students and families. Now I have to pay her tuition bill which is helping me to make the mental transition back to real life.

As daunting and exhaustive as the FAFSA seems, certain things are not included. Since these are often items that could be almost punitive in other circumstances, it’s worth exploring them in a little more detail.

Cash gifts to parents. If grandparents want to help with college, they may want to give directly to the student or pay the student’s tuition directly. However, if they give money to either the student or the school, it’s reported as student income in the “Money received, or paid on your behalf, not reported elsewhere on this form” section of the FAFSA. However, cash gifts to parents are not reported on the FAFSA. Thus a grandparent (or other third party) wanting to help would do best (for FAFSA purposes) to gift the money directly to the parents, who can then pay the bill using those funds. (Note that there are reasons why grandparents would want to pay directly to the school, so part of determining the right course of action is understanding where helping with college fits in their overall financial plan.)
Distributions from parent-owned 529 accounts. This is the secret sauce of 529s vs taxable investment accounts: Gain in the 529 account is not reported as income on either the tax return or the FAFSA. Parents of current college students should plan their FAFSA filing around tuition due dates, since most schools have a later FAFSA deadline for continuing students. If possible, parents should wait until after winter tuition is paid to file the FAFSA; those in a payment plan should make as many payments as possible beforehand. And as above, grandparents wanting to contribute can gift to parents, who can deposit into the parent-owned 529 and then distribute to the student.
Money in retirement accounts as of the date of the FAFSA filing. Parents planning to file in the fall might adjust 401k contributions to reduce money in taxable accounts, or make 2019 IRA contributions prior to filing. (Note: you can overfund retirement accounts such as by contributing to both a 401k and an IRA as long as you correct the overfunding by removing the excess by the tax filing deadline. If you delay, you will be penalized. Also, any gain resulting from the excess contribution is taxable income to you, so you’ll want to correct the excess as soon as possible.)
Credit card and student loan debt. Use your liquid assets to pay down debts prior to filing the FAFSA to reduce your assets, since assets are not reported net of consumer debt.
Employer contributions to retirement or HSA accounts. This can be a big benefit for self-employed people. Although employee 401k contributions are added back to income for FAFSA purposes, employer contributions are not as long as they’re reported on the business’ tax return, not the personal tax return. Self-employed individuals should consult their tax advisor to determine whether and how much of their 401k contribution can be an employer contribution that is not reported on Line 4 of the 1040. Same goes with HSA contributions: these are a business expense. (Note that if you’re applying to private schools, many will request the business tax return in addition to the personal tax return, even for a small business or self-employed individual.)
Mandatory retirement contributions. If your employer requires you to contribute a percentage of pay to your retirement, this is not added back to income because it’s not discretionary. Mandatory contributions are reported in Box 14, not Box 12, of the W-2.
Each child’s own assets and income are not reported on the other child’s FAFSA. If your family is like mine, where one is receiving need-based aid and the other is not, it can make sense to spend down 529 accounts and other assets differently for each child.
Income received from a work-study job. I’ll talk more about this when I talk about the student FAFSA inputs. Suffice it to say, work study is considered financial aid and therefore is not counted as income.

Obviously not all of these are applicable to every situation, and in many cases there are good reasons related to other aspects of your financial situation to do the opposite of what’s above. CPAs and fee-only financial advisors are a great resource in looking at how college planning fits in your overall financial picture.

P.S. Here’s Gabi walking in the UChicago Convocation procession. I love how happy she looks even as I miss seeing that smile in person.