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very confused about 401k as it affects EFC

ynot89125ynot89125 Registered User Posts: 129 Junior Member
Basically as the title states. My wife and I both max out our 401k at 15500 a year so totaling 31000 a year

Am i supposed to put that in the untaxed income??? that seems just completely unfair since we are only 40 years old and this money will have no impact on paying for my son's college.

and then i looked at this article: Reader Questions - How Does Our 401k Affect Our EFC? Should We Use Life Insurance to Save?

the first part seemed to confirm that our 401k doesn't have an affect on our EFC...

can someone clarify this for me? Thanks in advance
Post edited by ynot89125 on

Replies to: very confused about 401k as it affects EFC

  • ynot89125ynot89125 Registered User Posts: 129 Junior Member
  • hmom5hmom5 - Posts: 10,882 Senior Member
    The money already in the 401K will not be considered. Any money you put in during the tax year aid will be based on will be added back into your income.
  • ynot89125ynot89125 Registered User Posts: 129 Junior Member
    i still think that's ridiculous.
    but thx for the reply
  • calmomcalmom Registered User Posts: 18,618 Senior Member
    Yes, it is untaxed income because you get a tax break when you put the money into the 401K. But in most cases you will find that the hit on your EFC is outweighed by the tax advantage. That is, your AGI is reduced by $31K, so if you are in a 25% tax bracket, you save $7750 in taxes.

    Your EFC would increased based on the "untaxed" money - that is, lets say that if you don't put the money into the 401K, your EFC based on your income and other assets is $20K. You put the $30K in the bank instead, where it sits as an extra asset. As an asset, that $31K boosts your EFC by $1736-- (assets are "taxed" for EFC purposes at roughly 5.6%) -- so now you have an EFC of $21,736.

    If you put that money into the 401K instead, you still have the "base" EFC of $20K, but you don't have the additional hit for savings. Instead, however, because this income was not taxed, it adds to your EFC by a maximum of 47% x $7750 (the amount of tax savings) - which is $3642, putting your EFC at $23,642. That's an increase of $1906 over what it would be if you had put the money in the bank rather than the 401K. (Either way, the $31K counts toward your base EFC).

    So assuming that your child's college meets your EFC, the choice to put the money in the 401K means you have to pay slightly more than $1900 in tuition money -- but you SAVED $7750 that you didn't have to pay IRS. So your net benefit from putting the money into the 401K is $5584. So you need to reframe the question: is it a good idea to put $31K into your 401K if it will result in a net savings of $5584?

    Now of course this assumed a 25% tax bracket -- the higher the tax bracket, the more the potential savings (in reduced taxes).... BUT my analysis does not account for what happens if you have to pay Alternative Minimum taxes. (You'd have to redo the analysis).

    It also is based on the assumption that the college meets your EFC with grant money. Given the size of your 401K contribution, I'm assuming your EFC is fairly high - that's why I hypothesized a $20K "base" -- but maybe your EFC is $35K or $40K. The higher the EFC, the greater the likelihood that the college financial aid consists mostly of loans. If so, there is no real benefit with a lower EFC-- it just means that the college encourages you to borrow more.

    The other assumption is that the college will meet 100% of EFC. If the college does not make that commitment, there is no guarantee they will give you more money with a lower EFC. It may be that the college is going to give your kid a maximum of $8000 in grant money no matter how poor you are (NYU financial aid generally works like that, for example). If there is no guarantee of money... then a lower EFC is of no benefit whatsoever.

    So bottom line: if you can afford it, its worthwhile to continue to fund your 401K to the extent that you get a tax benefit for it. But with your earnings, you probably are dreaming if you think you will get much in financial aid anyway, so you had better start by running that "base" EFC calculation. If your EFC is more than the COA (which is very likely the case if your kid attends a public college), then you won't be getting money from the colleges.

    And then you have to ask yourself whether you have $31K to spare to put into the 401K the same year you are trying to pay your kid's college tuition.
  • ynot89125ynot89125 Registered User Posts: 129 Junior Member
    my EFC is around 35k

    i had heard ivy league schools give more need aid since they have so much endowment money.

    is this true? if so how much less do you think the EFC will drop to for the ivies?
  • sk8rmomsk8rmom Registered User Posts: 5,746 Senior Member
    Calmom is describing the FAFSA EFC process - are you talking about your IM or FM EFC? The Ivies and many other private schools use FAFSA only to determine federal aid eligibility (which, for you, will be 0 grants, $5500 Stafford loans). Their institutional aid is determined by their own methodology using CSS Profile which includes things such as retirement accounts and home equity which are excluded from FAFSA. Each school uses their own calculations but you may be able to get a good idea by looking at their websites. Some of them have calculators online. For a quick overview, most of the aid policies for no/low loan schools are summarized here:
    Project on Student Debt: Financial Aid Pledges
  • thumper1thumper1 Registered User Posts: 63,477 Senior Member
    if so how much less do you think the EFC will drop to for the ivies?

    First...EFC is something computed by the FAFSA. The Ivies have their own formula for computing family contribution as do many schools that award institutional monies. However, having said that...your EFC will likely NOT be reduced unless you get accepted at Stanford, Yale, Harvard which have very good need based financial aid for families earning up to $180,000. The first hurdle is to be one of the less than 10% of the applicants who get accepted. Do not COUNT ON getting into these schools...they are a reach for most everyone.

    It is NOT ridiculous to count your contribution to your retirement for the year and have it added back in as income. The reality is that this money could be used to fund college. There are some folks who max out their 401K accounts, and also have a Roth and traditional IRA for the husband and wife. Their annual contributions FAR exceed the $30K or so you are putting in your retirement. Do you think that families should be able to make a choice to fund their retirement in HUGE dollar amounts instead of helping with college costs? I don't want to get into that discussion here, but that is the issue. It's the same reason that families are required to include THEIR beneficiary share of a trust regardless of whether they have access to it.

    Need based aid if for students with family NEED. There are families out there who don't EARN what you are putting into your retirement. You are fortunate to be able to do this...but it is a choice when your child is in college.

    NOW....having said that, I would NOT advocate reducing retirement savings if you really don't have to. We also contribute the max towards our retirement but we are much closer to retirement age than someone in their 40's. We always said that if push came to shove, we would reduce our retirement contributions while the kiddos were in college to pay for college. THAT would have been our choice if it had been needed.

    P.S. yes, the Profile asks for the value of retirement accounts in addition to including the year's contributions as income. BUT I'm not sure anyone here knows quite what they do with that number. Speculation is that they want to see if families have been contributing to retirement in excess INSTEAD of thinking about funding their kids' college educations.
  • gorugoru Registered User Posts: 178 Junior Member
    So it really is a cash flow issue. If you have the resources to pay college bills over the next four years and fully fund your 401(k), you should continue your contributions.

    We took a hybrid approach. We stopped maximizing 401k contributions, but we still contribute up to the point that we maximize company matching contributions.
  • ncmentorncmentor Registered User Posts: 1,346 Senior Member
    calmom - very nice but did I miss the fact that you are also taxed on the 401k money when you take it out. Makes the "tax saving" harder to get at and likely a much smaller number.
  • thumper1thumper1 Registered User Posts: 63,477 Senior Member
    Actually we didn't think about taking money OUT of our 401L...we just planned not to put as much IN to the 401K during the college years...if necessary. I believe this is what Calmom was saying too.

    ynot...you should anticipating paying about $35K per year for your kiddo's college education....unless he/she gets accepted at Stanford, Yale, Harvard or schools with equivalent need based financial aid incentives. It is highly unlikely that your institutional parent contribution will be less than the FAFSA EFC.

    If your child is competitive for admissions to these highly competitive schools, that same child would be competitive for decent merit aid at any number of other schools. Do a search here for getouttabuffalo. This student got great merit awards (Pogue at UNC-Chapel Hill, McNair at U of South Carolina, for example) that fully funded college.
  • ncmentorncmentor Registered User Posts: 1,346 Senior Member
    Sorry - I was not talking about taking money out of your 401k now. But when you take it out at retirement it will be taxed. Contributions are tax free on the way in and taxed as income on the way out. Your income will likely be less but tax rates change too. I'm not saying a 410k is not a very good deal but it is wrong to say "you SAVED $7750 that you didn't have to pay IRS" - Your just not paying it "this Year".
  • thumper1thumper1 Registered User Posts: 63,477 Senior Member
    But when you take it out at retirement it will be taxed.

    If you wait long enough, your tax rate is reduced as a senior. In addition, our retirement income will put us in a lower tax bracket than our working income now.
  • ynot89125ynot89125 Registered User Posts: 129 Junior Member
    i did see that at least for harvard and yale, the financial aid policies are FANTASTIC. around 10% of your income if you make less than 180,000

    and yes i know that these two schools are VERY hard to get into.

    is there any other schools that have such incredible deals? it seems like its just these two even in the ivy league
  • thumper1thumper1 Registered User Posts: 63,477 Senior Member
  • notrichenoughnotrichenough Registered User Posts: 7,943 Senior Member
    I remember reading somewhere that some PROFILE schools will look at the amount of retirement assets you have, and "penalize" you if they consider the amount to be too high.

    IOW, if they think you haven't been saving enough in assets that are counted for FA purposes because you've been funding your retirement accounts instead, they will claw some of that back.

    I never saw exactly what was considered too much though... maybe one of the FA people here can comment on this.
This discussion has been closed.