How does a Windfall/Lottery Winnings Affect Existing Financial Aid and Future Reference Years

Paying for College
1

This is a hypothetical, nothing exists and probably will not, someone ran this scenario by me and I am curious how it would work.

Here is the assumption for a large family of 6. They are looking at a possible one time windfall some time this year. For lack of a more specific description, think of it as winning a scratch off lottery of $100k - $200k. Or if you prefer, as a signing bonus to a new job (salary would be unchanged from current job but signing bonus would be that) or maybe they sold their app or web site. Assuming they get it, as soon as they do it will be in cash and spent on credit card debts and roof repair, things that have no lasting value and do not change their asset profile. Not doing this on purpose, their roof is one step away from falling apart and they do have credit card debt that they need to eliminate. Even if they wanted to save the money they just have too many other obligations. Also, even if they saved every penny (which would be crazy if they have credit card debt), it would only change their EFC by $12K after the reference year, which while a lot for one kid is not that much for 3 or more kids. Parents are older as well and live in an expensive area that they cannot move from because of work.

For the scenarios below their family size is larger than average so they have kids in high school and middle school. In 3 years they will have 3 in college at one time and at least one in middle school. College, assuming a private school, full pay will cost well over $1,000,000 for the family without graduate school. Please note this windfall if it happens is unexpected and completely outside their control. It was not in the picture when their D1 applied to her meets full needs school nor was it something they ever expected to get. For the sake of the discussion, D1 cannot take a gap year, S1 and D2 will not be applying to state schools or any automatic merit schools located in the deep south but hope to go to similar meet full needs schools as D1 will be attending (yes I know the wisdom of this is questionable but different strokes). Prior to this windfall, when they ran the NPC based on 1-3 kids in college it was manageable based on how the numbers changed assuming meets full need colleges.

Hypothetical 1

For D1 her FA for next year is set, she has a package at an top tier full needs school that they are good with, it will be a struggle on their current income (EFC of 30k) but they will manage. Lets assume she filed the FAFSA and CSS last week based on their current non lottery income just to confirm the package she was already offered,

Am I correct in assuming that even if mom finds that scratch off $200k ticket tomorrow, that it does not change anything for her for this coming year? Will it change anything for her for 2017? Note this is REALLY a one time thing and while it seems like a lot of money, they currently have a lot of debts, obligations and at least another 3 kids to put through college in a short period of time. What happens in 2018 when their income goes back to normal and the windfall has been spent?

When her siblings start (with or without windfall), I would assume her need is reevaluated for 2017?

Hypothetical 2

S1 will be part of the class of 2017HS. His reference year will be 2015 (pre-windfall) how does a 2016 windfall affect his EFC and need based aid picture? Note he is a strong student but not as strong as D1 but should be able to get in to some full needs schools. he is not strong enough to get merit at the equivalent schools that offer it. Also, merit of 20k for a 60K would not be enough for each of the next 4 years. How will he be able to get his EFC to what it would have been without this one time item?

Hypothetical 3

D2 will be in the class of 2018. Her reference year will be 2016, the windfall year. By the time she applies in 2017 it will be a distant memory and will not help in providing for her education. How will that be treated? Can she choose to use 2017 as her reference instead if she gets her paperwork in on January 2? If they ding her in year 1 because of the now non existant windfall, will they reconsider her financial aid in Year 2? Obviously she will explain that it was a one time windfall.

Hypothetical 4

Same scenarios but instead of a lottery ticket, a previously listed Profile asset is sold such as a commercial property, which generates 100k, of which there is not much of a basis so there are capital gains on most of it but it really does not change their assets, just liquidates one piece. In this scenario it was also outside their control because there were partners who had decided to sell over the parent’s objections.

If you managed to read this far, thank you

2

So the hypothetical lottery ticket/rental property would appear as “income” of some sort during the tax year in question, correct? And thereafter, what remains would be considered assets?

3

Yes, for the tax year that it was won or the sale occurred.

4

If it is cash, like a lottery payout, it will show on the FAFSA for the future year, i.e., in 2016 instead of $60k in income she will show parental income of $160k. It would not change awards for year 2016-17, and in fact the 2015 taxes will be used for 2017-18 FAFSA, so it will not show up until 2018-19 filing.

There may be a question on the 2016-17 FAFSA (or on the CSS, I don’t know that one) that asks about other sources of income and assets on the date of filing, so if that $100k is sitting in a bank account on October 25 or November 10 when the family fills out the FAFSA, it would be an asset.

As far as selling an asset, the tax picture would change on 2016 taxes (which won’t be used until the 2017-18 FAFSA). Income may go up, which means EFC would go up.

It seems you are trying to justify having an extra $100k in income and using it to pay for expenses and debts, but wanting it not to change the EFC. It is going to show up at some point.

5

Thank you

Yes it will show up at some point, they would like to know when so there is no surprise. Also, since the money will be gone by the time they file the following year (again not deliberate, they just have a lot of expenses), they are not worried about it being an asset.

Also, since for one of the kids it will be during the reference year, will this disadvantage him or her or the whole group for the next 4 years. I have read posts on here where people have said, we got lucky because we had a bad ______ (insert reference year) so we got more aid than we would have gotten in another year and that carried forward for all 4 years.

Also, since D1 is going (to use the example above) from an income of 60 when she applied, to 160k in year 1, back to 60k for years 2, 3 and 4, what will that do to her aid (in general, I realize no one her works for Top Tier school FA office) and when will it do it?

6

This is a bit of a fallacy- if you win 100K in the lottery you don’t get 100K next week. You see the award NET of taxes- federal, state, local if applicable. Or you pick a pay-out plan which sends you a check every month for life
 or once a year for the next ten years
 or whatever payout you choose.

If you get a 100K signing bonus from a new job you don’t get 100K- all the typical deductions apply before you see your check.

Etc.

So what exactly are you trying to figure out???

7

I was trying to make this simple. They are handed a check for $100k-200k that was NOT an inheritance and the whole amount is subject to capital gains or ordinary income taxes. Yes they will pay taxes on it but so does the family that earns $160k or $260k to begin with and is not eligible for FA to begin with.

Simply put year 0 eligible for FA EFC 30k

Year 1, get lottery etc EFC goes up to 200k (guessing here, not my question HOW much EFC, lets assume it makes them ineligible)

Year 2, 3, 4, 5 EFC is back down to 30k because income is 60k again and lottery assets have been spent

Year 1 is the reference year for one of the kids, can they choose to use year 2 instead?

How will FA be from year to year since this was a one time thing not a permanent increase in salary, How will existing FA be hurt due to a one time windfall?

8

At a college which promises to meet full need AND the family’s assets AND income (so it’s not just that they earn a modest salary, it’s also about their assets) qualify them for aid, I would use the correct reference year (it’s always nice to follow both the letter and the spirit of the law!) and ask for a professional judgement to review the families finances, pointing out the one time only boost from a “never to be repeated” event.

9

blossom, you may not get the check for the whole $100k if they take out taxes, but you’ll get the 1099 for the entire amount, and taxed on the entire amount as unearned income. If you win the lottery, you usually do get the entire amount (less withholding) unless it is a specific game like $1000/wk for life (and in that case, it’s not a one time windfall for taxes). Even the million dollar winners can take a lump sum option. The OP gave the parameters for his question, a lump sum windfall.

I think there are some schools that give financial aid based on the first year, but not all do. Pell and other federal grants are going to be reassessed every year. If the D3 is worried about not getting a good financial aid package because she has the ‘bad’ tax year as her base, she should go to a school that awards FA yearly. If she/family is going to restrict the pool of colleges to only LACs in the Northeast, she’s going to have to restrict the pool even more to only those schools that look at CSS/FAFSA after the first year too.

10

I couldn’t get through the whole thing. But I think you are making it out to be waaay more complicated than it is. In fact, it’s not at all complicated.

The year in which you get the 1099 for the windfall, that money is part of your income. If you normally earn $75k, and you get a windfall of $100k, your income for that year is $175k. Whether you spend it right away to pay off debts and get a new roof is irrelevant. It’s income. FA office doesn’t want to know about your roof or your consumer debt.

As for subsequent years, there would be no windfall income; your income would be back to $75k. If there is anything left over from your windfall the previous year, it would be counted in your assets.

Don’t all the colleges ask you to submit a Fafsa every year? Are there really colleges that base all four years of FA on what you submit in year one? That sounds crazy.

Also, you could explain in a separate letter to the FA office that the $100k was a one-time windfall that was used to pay off debts from when there was unemployment, unusual medical expenses, or whatever the reason was.

Am I missing something here?

11

Could tax averaging come in to this some how? (I am not an accountant or even close.) Do Profile colleges have some way of acknowledging this sort of one time windfall and spreading it over years?

12

There is no tax averaging and hasn’t been since 1986.

1 Like
13

To reduce the effect of a windfall in 2016 on Kid1 (already in college) and Kid2 (currently planning to apply to college to start fall 2017), one possible plan would be for Kid1 to take school year 2017-2018 off and return beginning fall 2018, and for Kid2 to take a gap year and apply for college to start in fall 2018.

14

Thank you

@happymomof1 that is creative! Not sure it will work for them but it is creative. One problem with a GAP year is that financial aid is set when you apply in senior year not when you attend.

The roof and the credit card debt is irrelevant, just making the point that by year 1 or 2 the money will have been spent.

For those who asked, what they are trying to understand is

  1. How much existing financial aid will change for a Profile full need school due to a one time windfall that eliminates FA eligibility for that year (or would if it were the reference year). If the student is class of 2020, already has their freshman award and the event happens in 2016, which year would they lose FA or would they? What happens the next year when they go back to their regular salary.

If they know they will not qualify should they simply decide not to submit their FAFSA and CSS that year?

  1. If 2016 is the reference year, what happens to aid if that is abnormally high income? For a student who is entering in 2018 can they possibly use 2017 as the reference year if they get their paperwork done early in 2018?

Has anyone experienced this? I am sure it is common with people who sell assets (are in real estate) or work on commission and make a big sale in one year and not in others or who get a severance package but are able to find another job while receiving severance. All similar situation. The tax liability does not matter because they will get either a 1099 or W2 showing the full amount received.

15

@SeekingPam

Ok
ill talk about the elephant in the room.

If this family has this HUGE windfall
wouldn’t it be nice if they used some of it to pay for college costs?

It sounds like they are looking for a way to shield this money from being assessed by the financial aid offices.

I believe this windfall will be considered unearned income for the year in which it is received.

AND if it’s sitting in the bank the day they file their financial aid application forms, it will also count as an asset.

16

Many have asked if the ‘prior prior’ tax year is optional and if the family can opt to use the ‘prior’ year only (current system). It will be new to all next year, but it appears it is not as optional as we’d all like it to be, and everyone must use the prior prior year, so for 2018-19, everyone will use 2016 tax information even if the FAFSA is not filed until Jan '18.

You know, it is really income and if they want to accept the money (sell the property, win the lottery), it’s income. Whether they use the money for a roof or credit cards or (gasp) tuition doesn’t matter. They might be able to convince each college that the money was a one time thing and they needed it to pay one time debts. Might work, might not. If I were a FA officer, I know how I’d rule, but they might find someone nicer than me.

17

@thumper1 THERE IS NO ELEPHANT IN THE ROOM. It is absolutely clear to me that for one of the years they will lose ALL financial aid. They will most likely have to use most of the windfall to pay tuition in that year. That is a given. The question is WHICH year and to what extent does it change FA for an existing student. The point is, a year later all that money is gone and they are no longer on the same footing for financial aid as they were before the windfall even though economically they are in the same place. Ironically they could be worse off.

Part of the reason for the questions is they are in the process of negotiations, lets say to sell their app. While it may be nice to get $100,000, they need to understand how much they will be left with. I am concerned that at a certain point, while it sounds almost impossible, they could be worse off. Follow my logic and please point out any flaws. They have an EFC of 30k now. With two kids that becomes an EFC of about 45k (guessing here). Assuming the 100k extra they EARN (yes folks I know its earned income), makes them ineligible for aid, their EFC now goes to 130k (from 45k for two kids). They are now paying 85k of the 100k for college and they are paying at least 30% of their windfall as capital gains tax. So according to my math, that extra 100k they got costs them $115k. Plus it potentially could impact their financial aid for future years since their reference year was so high. PLEASE PLEASE TELL ME I AM WRONG?

@twoinanddone that was very helpful. Bottom line they are stuck with the prior prior year as the reference year, even if they want to use the prior year. Once a kid has matriculated, can they use the prior year instead of the prior prior year

18

@SeekingPam - The suggestion I made is not original. It came from another poster a year or two ago who wrote about a friend who needed to do exactly that because of a one-time windfall. Their Kid1 took a year off, ans their Kid2 took a gap year and applied to college during the gap year. I don’t know if Kid2 applied early anywhere that needed a CSS/Profile from the possibly-windfall-year, or if Kid2 only applied to places that wouldn’t need anything until the post-windfall-year. Maybe whoever knows about that case will see this thread and chime in.

Financial aid is recalculated each year and goes up or down as the family’s need goes down or up. However, many places do not guarantee to meet full need so even if the family’s need increases significantly, there is no guarantee that the aid package will increase. It looks to me like this particular Kid2 needs to wait until this money has been received, taxed, and spent before applying to college so as to optimize the potential for a decent financial aid package. Whether this Kid1 also needs to plan to take a year off would be a separate question.

19

Best bet would be for them both to since it increases the number of years all 3 kids are in school together. It is highly unlikely they will but who knows. They will mostly be applying to meets full need schools, that is what K1 will be attending.

20

One place you are wrong is that they’ll either pay taxes on the windfall as income (earned or unearned) or it’s a capital gain, but it won’t be both. I really didn’t follow your EFC jumping from 30 to 45 to 115. If the EFC for one child in school this year is $30k, for two children it should drop to $15-18k each if income stays the same. If income goes way up, but the EFC is now for 3 children, it’s impossible to know what it will be. For an EFC of $30k for one, I’m guessing income was about $110k, Now income could be $200k, but the EFC would be split among 3 kids, so maybe $30k each? I don’t know. You are also stuck on this idea of a ‘reference’ year. What school is it that won’t look at financial aid every year, especially when there was a high income in one year and there are different numbers of kids in school every year? If the oldest goes to this school with the ‘reference year’, wouldn’t her EFC be locked in at $30k? And wouldn’t the second, who has already filled out the FAFSA without the windfall, be locked in at $15K? That’s why I don’t think there is a reference year, and if there is, the third child just has to take a gap year or live with the high, locked in EFC.

Simple answer is don’t take the windfall, don’t sell the asset, don’t sell the app (which it seems is what we are talking about). Some people do keep their incomes low to qualify for a better tax rate, government services, and student aid. In California it is very important to keep your income below $80k to qualify for the best grants. Yes, earning $200 over the limit may cause you to lose $6000 or more in benefits. I have a friend whose daughter absolutely had to qualify for medicaid. No way could friend afford private insurance, and no private insurer would take her anyway since she was over her lifetime limits. So until her child was an adult, this friend knew that limit of what she could earn in a year. No raises, bonuses, overtime. She made the limit and not a penny more.