FAFSA Simplification: What You Need to Know
Part 1: Timing and Income
Last week the Department of Education announced that this year's FAFSA will come out in December, not October. We now have some additional information about FAFSA Simplification and what's in store, so let's dig in!
December?
Yes, this year the FAFSA will be released in December, not October. That's to accommodate the myriad changes that need to be implemented, not just by the Department of Education but by colleges, state education departments and other entities that use FAFSA data. My *guess* (note the emphasis on guess) is that it will not come out Dec. 1, because the announcement also said that the toolkit for professionals who use the FAFSA will also be released in December. This is a one-time delay; in 2024 and subsequent years the FAFSA will be released on Oct. 1.
Changes present planning opportunities, and this one is no exception. Of course, last-minute FAFSA planning is asset planning, but this could be a big planning opportunity. First, families have two additional months to spend down or transfer assets prior to filing. Second, Jan. 1 is not long after December, and depending on college's FAFSA due dates, families might be able to delay filing until after Jan. 1 and make 2024 Roth IRA contributions prior to filing.
Changes to Income Inputs
Income-- especially parent income-- will see some big changes, most of which will benefit lots of FAFSA filers. The biggest change is that pre-tax salary deferrals to employer retirement plans-- 401ks, 403bs, 457s and the like-- will no longer be added back to parent income. That's a huge win for parents who want to both save for retirement and reduce their Student Aid Index (the new name for the Expected Family Contribution). Previously, pre-tax contributions were added back to income, and since they reduced parents' tax liability, actually increased EFC.
Why did I use the really unwieldy phrase "pre-tax salary deferrals to employer retirement plans-- 401ks, 403bs, 457s and the like"? Because other pre-tax retirement contributions-- those made to traditional IRAs or self-employed retirement plans like SEP IRAs-- do still get added back.
The FAFSA will only use tax return data, so any untaxed income that's on your tax return will still be added back. That includes:
Traditional IRA contributions
Contributions to self-employed retirement plans including SEP and SIMPLE IRAs
Roth IRA distributions and untaxed pension distributions
Tax-exempt interest income
If you're unsure whether your retirement contributions are reported on your tax return and therefore added back, check Schedule 1, lines 16 and 20, of your tax return. If anything is in there, it gets added back.
Income gets some other adjustments, too:
The Income Protection Allowance has increased but is no longer adjusted for number of college students in the household. This year a family of four gets an IPA of $35,870, regardless of how many college students they have. Going forward, the IPA is not adjusted based on the number of college students in the household because the FAFSA will not divide SAI by the number of college students in the household. Up until this year, the IPA decreased by about $3,600 per student in college. Families with multiple students will benefit a little from the larger IPA, but not enough to offset the SAI not being divided by number of college students.
Everyone who works gets the Employment Expense Allowance, an allowance of up to $4,000 against income. Previously only two-parent households where both parents worked were eligible.
The formula includes some tweaks that will benefit low-income families. For example, Parents' Available Income (the sum of income sources minus taxes and allowances) can be a negative number. In addition, the threshold for eligibility for the Simplified Formula, where no assets are reported, has increased to $60,000 of income.
Child support received is now reported as an asset, not income. That means a parent receiving $500 per month of child support would report an asset worth $6,000 (assessed at 5.64% = $338 added to SAI) rather than $6,000 of income (assessed at up to 47% = up to $2,820 added to SAI).
The biggest planning opportunity in all of this is of course reducing income by increasing contributions to pre-tax employer retirement plans in FAFSA income years. This is also beneficial for families where FAFSA income years overlap American Opportunity Tax Credit income years. Keep in mind of course that the FAFSA uses prior-prior year income, so changes you make in 2023 will be reflected on the FAFSA you file in fall of 2024 for the 2025-2026 school year.
Remember, too, that so far, these changes only apply to the FAFSA, not the CSS Profile. That's both positive and negative: the CSS Profile will continue asking how many college students are in the household and dividing accordingly. Whether the Profile eliminates adding back pre-tax salary deferrals into employer retirement plans is an entirely different question.
FAFSA Simplification info continues here.
