529 and Roth IRA withdraw and financial aid

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paulsiu
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529 and Roth IRA withdraw and financial aid

Post by paulsiu »

The consensus on this board appears to be that contributing to an Roth IRA is superior to a 529. Roth IRA can be used to pay education expenses tax free.

However, I did notice that Roth IRA withdraw are counted as income for financial aid and 529 is not. is this true?

Paul
SimonJester
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Re: 529 and Roth IRA withdraw and financial aid

Post by SimonJester »

Here is a good article that explains this:

http://www.moneycrashers.com/roth-ira-c ... education/


Basically you will be taxed on your Roth IRA earnings if you use them for education. Earnings will be counted as income for financial aid.
Using contributions will not have an effect on financial aid.

A 529 in the parents name have an effect on financial aid but less then if its held in the students name.
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grabiner
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Re: 529 and Roth IRA withdraw and financial aid

Post by grabiner »

SimonJester wrote:Here is a good article that explains this:

http://www.moneycrashers.com/roth-ira-c ... education/


Basically you will be taxed on your Roth IRA earnings if you use them for education. Earnings will be counted as income for financial aid.
Using contributions will not have an effect on financial aid.
That article doesn't look right. Checking from the horse's mouth:

Free Application for Federal Student Aid
Expected Family Contribution formulas

FAFSA line 94e says to report as "untaxed income" the total IRA withdrawal, minus any amount taxed. Thus, if you withdraw $15,000 from an IRA (traditional or Roth), and $5000 of that is taxed, you will report that on your Form 1040. For EFC purposes, you report $10,000 as untaxed income, and the EFC formula counts the full $15,000 towards your contribution amount.

The same rules apply to students. A Roth IRA owned by the student is not counted as an asset, but if the student withdraws from it (even tax-free), 50% of the amount withdrawn will be added to the EFC for the next year.

529 withdrawals are not counted as income, but the 529 is counted as an asset.

Thus, if you are funding college with both a 529 and Roth IRA, you want to deplete the 529 first, to reduce assets for EFC calculations in future years. When the 529 is gone, you can withdraw from the Roth IRA in January of the student's junior year or later, so that the Roth withdrawal will be in a tax year which does not affect EFC (unless you have other children still in colllege after the first one graduates).

(edited to fix typo)
Last edited by grabiner on Thu Mar 05, 2015 1:55 pm, edited 3 times in total.
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paulsiu
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Re: 529 and Roth IRA withdraw and financial aid

Post by paulsiu »

I have read the moneycrasher article but was suspicious of the accuracy because it runs counter to the other articles. Basically what I can determine is:

* 529 are counted as an asset, which mean it gets counted as roughly 5.6% if it's under the parent's name. The withdraws are not counted in the EFC. From the financial aid office point of view, you are tapping into an asset. Note that this counts for asset for parents. I believe 529 from grandparents for example may not be counted the same way.
* IRA are not counted as an asset. Financial aid will not count 401K nor IRA as part of your asset when calculating EFC.
* Traditional IRA withdraws raises your AGI and so will be counted as income for EFC calculation.
* Roth IRA can be tapped for educational purposes. If you are under 59-1/2, only the contribution are tax free, but earnings are not. When you withdraw, it is assume that the contribution are withdraw first. Taxed contribution shows up as income in your AGI, and is counted as income for EFC calculation. If your withdraws are tax free, it won't show up in your AGI. However, financial aid applications will want you to report it as untaxed income to be used in the EFC calculation.

I need to think about this some more on the effects.

Paul
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Re: 529 and Roth IRA withdraw and financial aid

Post by livesoft »

Today there are tax credits for spending money on qualified education expense for folks with moderate incomes. Some of these credits are use 'em or lose 'em, too. Thus if a Roth withdrawal is needed to use the credits, then would that offset any reduction in EFC?

Frankly speaking, my opinion is that if a family can contribute to a 529 plan, then it is unlikely that they will be eligible for financial aid. Maybe I need poll to figure out how common it is for a family that uses 529 plan money for college gets any financial aid?
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grabiner
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Re: 529 and Roth IRA withdraw and financial aid

Post by grabiner »

livesoft wrote:Today there are tax credits for spending money on qualified education expense for folks with moderate incomes. Some of these credits are use 'em or lose 'em, too. Thus if a Roth withdrawal is needed to use the credits, then would that offset any reduction in EFC?
It really depends on what the college does with financial need. Withdrawing $10,000 from a Roth IRA tax-free will increase EFC by $4700. If this costs $4700 in grants (because the college meets all need with grants), this is more than any tax benefit.

A better strategy in this situation might be to get the $10,000 from another source which is not income for EFC purposes, such as taking a home-equity loan or 401(k) loan, or reducing your retirement contributions as long as you do not lose a match. (EFC counts retirement contributions as part of income, because they are discretionary spending.) You could withdraw from the Roth IRA to pay off the loan after it no longer counts against EFC.
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Re: 529 and Roth IRA withdraw and financial aid

Post by happymob »

Keep in mind that different posters come from two very different places - 1) financial aid isn't going to happen or 2) financial aid considerations matter. In the first case, the Roth is almost always better (if it is truly a choice between the two). In the latter case, gaming FAFSA gets pretty complex.
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paulsiu
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Re: 529 and Roth IRA withdraw and financial aid

Post by paulsiu »

Strategy will depend on a lot of factors. I am trying to figure out each factor. This is why the question was specific.

http://www.forbes.com/sites/troyonink/2 ... llege-aid/

According to the site, I will be in the yellow area, which means there is eligibility for 4 year private colleges and elites schools.

Paul
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Re: 529 and Roth IRA withdraw and financial aid

Post by livesoft »

paulsiu wrote:According to the site, I will be in the yellow area, which means there is eligibility for 4 year private colleges and elites schools.
I wouldn't get my hopes up. We were in the blue zone and received no financial aid from 8 different universities (7 private and 1 public).
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livesoft
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Re: 529 and Roth IRA withdraw and financial aid

Post by livesoft »

grabiner wrote: (EFC counts retirement contributions as part of income, because they are discretionary spending.)
This is so true and was a real eye opener when I learned this 5 years ago. Bogleheads are so used to the mantra of maxing out retirement plan contributions that they treat these as a mandatory expense and not really as available income.

That is why I believe families saving for college should still max out retirement plan contributions before putting one cent in a 529 plan. First, the contributions reduce their spendable income and the family gets used to living on less. Second, money in those plans are not counted as assets to be used for college at all. Third, if needed, the family can just stop contributions during the college expense years to help pay for college. They may not need to withdraw from a retirement plan to get their hands on extra cash if they simply stop contributions.

So if one is in the "yellow" zone and making retirement plan contributions, then be sure to add those contributions to your AGI to get a better estimate of a possible EFC.
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paulsiu
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Re: 529 and Roth IRA withdraw and financial aid

Post by paulsiu »

livesoft wrote:
grabiner wrote: (EFC counts retirement contributions as part of income, because they are discretionary spending.)
This is so true and was a real eye opener when I learned this 5 years ago. Bogleheads are so used to the mantra of maxing out retirement plan contributions that they treat these as a mandatory expense and not really as available income.

That is why I believe families saving for college should still max out retirement plan contributions before putting one cent in a 529 plan. First, the contributions reduce their spendable income and the family gets used to living on less. Second, money in those plans are not counted as assets to be used for college at all. Third, if needed, the family can just stop contributions during the college expense years to help pay for college. They may not need to withdraw from a retirement plan to get their hands on extra cash if they simply stop contributions.

So if one is in the "yellow" zone and making retirement plan contributions, then be sure to add those contributions to your AGI to get a better estimate of a possible EFC.
You are quite right. Financial aid do not factor your contribution into retirement plan, so folks hoping to catch up gets a double-whammy during college years. It's more important to contribute to your retirement first.

In my case, by the time college rolls around, I will be nearing retirement, so I am hoping that my contribution will not make too much of a dent in the portfolio, so I can divert the funds to college instead, though college will still be way more expensive than retirement contributions.

Paul
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Re: 529 and Roth IRA withdraw and financial aid

Post by TomTX »

livesoft wrote:
grabiner wrote: (EFC counts retirement contributions as part of income, because they are discretionary spending.)
So if one is in the "yellow" zone and making retirement plan contributions, then be sure to add those contributions to your AGI to get a better estimate of a possible EFC.
I thought if one got AGI below $24k and used a 1040EZ, that was it. No EFC.
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Re: 529 and Roth IRA withdraw and financial aid

Post by Jack FFR1846 »

A couple additions: if a grandparent or someone other than the parents have a 529, its best from a FASFA point of view to use the money in the last year after the FAFSA has been filed if there is any chance for financial aid. This is because non-parental 529 income is treated as student income, which is the worst thing for EFC.

Also, as the parent of a college freshman who is doing so well in his engineering course that he is likely transferring to a better (CSS) college next year, from what I see of the CSS, much more must be declared, including primary home value and retirement account value. There is less to "hide" assets in.
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