A lot of people ask about how to prepare for the FAFSA. Doing the FAFSA is a lot like doing your taxes. You can absolutely wait until April 15 to fill out your 1040, but you’ll probably save some money by thinking about your taxes in the fall and taking some steps before the end of the year to mitigate the bill. Similarly, if you wait until fall of senior year to think about the FAFSA, you’ll miss out on some planning opportunities since the biggest FAFSA component—parent income—is already fixed from your prior year’s tax return. Nonetheless, any understanding of how the FAFSA’s four elements work can be helpful, as is a review of what year of each component counts towards which FAFSA. And of course, the most important thing is what each school you’re interested in does with the FAFSA (net price calculators are your best bet for that). Remember that schools are not obligated to meet your need, and especially not through scholarships. Rather, think of the FAFSA’s purpose as allowing schools to assess all applicants’ financial status on the same metrics.
Parent Income is, for most families, the biggest piece of the FAFSA. The FAFSA uses income from the most recent tax return available by the time the FAFSA is released, which for this fall will be 2019’s income. Parent income is assessed in brackets, just like taxes, at rates up to 47%. That means that every incremental dollar of income will increase your Expected Family Contribution by 47 cents. In addition to taxable income, you must add back pre-tax retirement contributions and untaxed income such as child support. The FAFSA has a nominal income protection allowance—approximately the federal poverty level for a family of your size—and you subtract actual federal taxes and an allowance for state taxes. That means, for example, that making Roth contributions to your IRA or 401k can be advantageous in FAFSA years because you’ll pay more taxes which means you’re subtracting more taxes from your income. Similarly, reducing deductions such as charitable contributions or mortgage interest by shifting them into other years can lower your EFC.
Student Income tends to be a lesser factor since dependent students get an income protection allowance of $6,970 on this fall’s FAFSA. Few students earn more than that while in high school or the early college years. However, students do report as income any distribution received from a non-parent-owned 529 or any contribution to college costs from anyone other than the custodial parent(s). This is an important planning piece for students whose parents are divorced, or for students with financial need who have grandparent- or other non-parent-owned 529 plans. Because of the prior-prior year income reporting, students with financial need will be better off waiting until January of their sophomore year in college to tap into those types of assets, since students on a four-year path will not report income from that point forward on their FAFSA.
Parent Assets are first given an Asset Protection Allowance. For most married parents, that will be somewhere between $6,000-$8,000; single parents get less than half that. (The actual number is based on the age of the older parent.) Then, assets are assessed at 5.64% of their actual value. That means that a parent with a $6,500 asset protection allowance and $10,000 in assets would only see their EFC increased by $197. Retirement assets do not count; however, everything in your checking, savings, investment and 529 accounts (for all children) on the date you file the FAFSA do. Families can reduce their assets by paying bills and making retirement contributions for the year prior to filing the FAFSA.
Student Assets penalize you far more in the formula than do parent assets. Students do not receive an asset protection allowance, and their asset are assessed at 20% of their value. That means that $1,000 in a student’s bank account will increase EFC by $200. Students who will be contributing to their college costs from their own savings would benefit from transferring their money into a 529 account. In many cases, they’ll receive a state tax benefit for doing so, too. What tends to hurt students the most in the formula are UTMA accounts. Families can transfer UTMAs to custodial 529 accounts where they are then counted as parent assets. However, UTMA assets need to be sold; any gain realized between Jan. 1 of sophomore year in high school and Dec. 31 of sophomore year of college would be student income on a future FAFSA.
Parents of current seniors, your primary FAFSA planning opportunity is around your and your student’s assets. Parents of younger students have some opportunities to work on their income for FAFSA purposes. However, the biggest planning opportunity is learning what different schools do with your FAFSA. If you are the parent of a senior, you and your student should be doing net price calculators for every school the student is interested in attending. Those estimates are far more important than your FAFSA.