My daughter returned from her first year of college earlier this month. Yay! Not far behind were her high school friends. Tired from the long winter and a challenging freshman year they are enjoying a well-earned break sleeping in, catching up with friends, and revisiting favorite hangouts like Cup-and-Cone in White Bear Lake.
Most of them also have jobs lined up for summer. Some even have two or more. Good for them. Summer job opportunities for young people have never been better. If they are smart, they’ll stockpile cash like squirrels hoarding food for winter.
Making money is always a good thing, in my view, but some may fear the loss of college financial aid benefits if they earn too much. In fact, dependent students can earn up to $7,040 this year with no impact on their portion of the Expected Family Contribution or EFC. After that, 50 cents of every dollar earned will count as student income when they complete the FAFSA form in 2023.
What they do with their savings could have more of an impact on financial aid than the actual amount earned. The EFC assesses student owned assets at a rate of 20% compared to just 5.6% for parent-owned assets.
Of course, if you do not qualify for need-based financial aid, what the student earns and how their assets are owned is a non-issue. But if you do receive need-based college financial aid benefits, smart management of those funds could result in more financial aid and ultimately more money that stays in your pocket.
Roth IRAs. The IRS says that anyone with earned income from a job may contribute up to $6,000 to a Roth IRA. The U.S. Department of Education, the people behind the FAFSA, says that IRAs of all types, including Roth IRAs, are exempt from the Expected Family Contribution (EFC).
Since the EFC determines your financial need and ultimately how much financial aid you may qualify for, you want to keep this number as low as possible. Adding money to a Roth IRA means that when you complete the FAFSA form, these assets will not count against you for purposes of financial aid. Even if you add $6,000 a year to Roth IRAs, they will have no impact on financial aid for college.
Roth IRAs do have some disadvantages for college students. The asset is exempt on the FAFSA form, but distributions are considered to be “untaxed income” and must be included as student income on the FAFSA. The workaround is to accumulate money in a Roth IRA during the first years of college but avoid making any distributions until after you have completed the FAFSA form for your final year of college.
This way, the asset is exempt, and distributions will fall on a tax year that has no impact on your EFC.
Like all Roth IRA owners, students who contribute to Roth IRAs don’t have to take money out of their IRA – ever. When they do the original principal is available tax and penalty free. Roth IRA earnings distributed before the IRA owner turns 59 ½ will be taxable and subject to penalties.
Effective use of the Roth IRA for college will require comparing the gain in financial aid benefits from doing the Roth with any penalties or taxes that may be due on the distribution.
Prepay college expenses. When students and parents complete the FAFSA form they must disclose the value of their assets as of the day the form is filled out. If a student has $5,000 of savings at the end of the summer, she may use that money to pay a portion of her college expenses. When the FAFSA form is completed in October, you will accurately record a $0 asset balance in the name of the student if she has spent all her money prior to filling out the form. Here, the key is to make sure the money is spent on college and not on, well, Cup-and-Cone.
Work study. A work-study program at your student’s school is actually a form of financial aid. As such Income earned from work-study is exempt from the financial aid calculation. So, if your student works 8-10 hours a week earning $12 per hour during the school year, those earnings would be exempt from the $7,000 earnings limit for students on the FAFSA form.
For students who receive need-based financial aid or subsidized student loans, the key to preserving financial aid benefits is to keep their eligible income below $7,000 and to make sure they have little, to no, money in their name when they complete the FAFSA form in the fall. Funding a Roth IRA and prepaying the student’s share of their education expenses from money they earned goes a long way towards doing that.
To discuss any of the topics in this blog or to learn more about how we can help you Cross The Bridge To A Confident Retirement, please contact me through my web site mikebranch.net, call me directly at 651-379-3935 or email me at mpbranch@focusfinancial.com.