How to reduce MAGI for filling FAFSA [deduct IRA, Convert]

[pindella]

I read that I can still open a traditional IRA for 2012 until April. If it is correct, how can I show this deduction when I am filling Fasfa for my daughter. And the second question, if I decide to convert a Traditional IRA to a Roth IRA after filling FASFA, are there any fees for conversion? Thanks

[grabiner]

See the FAFSA instructions at
http://www.fafsa.ed.gov/fotw1314/pdf/PdfFafsa12-13.pdf

Parents' deducted IRA (and 401(k)) contributions are counted as untaxed income (line 92b), and taxed and untaxed income are both counted as your income for financial aid purposes. Thus contributing to an IRA will not reduce your Expected Family Contribution. In fact, for a deductible IRA, it will increase your Expected Family Contribution because it reduces your income taxes, but this may still be a good deal because it also gives you money back on your taxes.

However, you are supposed to report assets as of the date you file the form. If you make the IRA contribution (traditional or Roth) by writing a check or selling some other investment before you file the FAFSA, then your assets will decrease (IRAs are not counted as assets) and thus your Expected Family Contribution will decrease.

And the second question, if I decide to convert a Traditional IRA to a Roth IRA after filling FASFA, are there any fees for conversion?

Whether there is a fee for conversion depends on whether your IRA custodian charges one; most don't. If you deducted the traditional IRA contribution, you will owe tax on the conversion to a Roth IRA. If you didn't deduct the contribution, you will only owe tax on the gain.

However, if you convert, the non-taxable portion of the conversion is still considered non-taxable income in 2013 (line 92e), so it will affect next year's Expected Family Contribution if your daughter is still in college. If your income is low enough that you are eligible for a Roth IRA, you should contribute directly to a Roth IRA before you file the FAFSA. If you aren't eligible for a Roth IRA but are eligible for financial aid, it's probably better to open a Traditional IRA and wait to convert until January of your daughter's junior year when it will no longer affect the FAFSA.

[pindella]

Thank you for your reply, it was very helpful. My Gross income was $60,395 and i am filling as a head of the household. My daughter is a junior, however it will be the first year we are eligible to apply for FAFSA. We have 2,5 years ahead of paying tuition. I don't have any assets and we have about $6k in checking accounts. I understand that you recommend to open a Roth IRA instead of regular IRA. My daughter is also considering opening an IRA account from the money she earned in 2012 which was $4k. I was thinking that it is not a bad idea provided that she can take money (if needed)for the eligible educational expenses and as a first time home buyer. What would be your advice?

[grabiner]

My Gross income was $60,395 and i am filling as a head of the household.

I understand that you recommend to open a Roth IRA instead of regular IRA.

You are in a 15% tax bracket. For every $100 you contribute to a Traditional IRA, you reduce your taxes by $15, and you don't even get the full benefit of that reduction because of the increased Expected Family Contribution; you will then lose 15% to taxes if you withdraw the money in a 15% bracket. If you contribute $85 to a Roth IRA instead, you will pay less out of pocket and lose nothing to taxes.

My daughter is also considering opening an IRA account from the money she earned in 2012 which was $4k. I was thinking that it is not a bad idea provided that she can take money (if needed)for the eligible educational expenses and as a first time home buyer. What would be your advice?

This is actually even better; she can take Roth IRA contributions out at any time without penalty. The first-time home-buyer rule allows her to take an additional $10,000 earnings penalty-free and tax-free if she has had the Roth IRA for at least five years.

In addition, the money she puts in the Roth IRA won't be counted as her assets for FAFSA purposes, as long as she has made her contribution before you file the FAFSA. (However, if she withdraws it in 2013 and you have to file an FAFSA based on 2013 income, the withdrawal will be counted as income and 50% will go towards her Expected Family Contribution.)

[pindella]

Thank you very much for your answers. I tried for a week to get answers from different sources and could not get the informartion I needed to make a decision. You aswers were very helpful.