In my experience, most parents believe that once their child has started college and received her financial-aid offer, they can stop paying attention to future financial aid requests. Often overlooked is that financial-aid offers generally are in effect for one academic year and must be renewed every year. Simply put, families must reapply for financial aid each year a child will be in college.
Making a single incorrect financial decision during your child’s college years could upend years of proper planning. These are some of the most common mistakes that should be avoided:
Making withdrawals from IRA accounts
Normally a distribution from a traditional Individual Retirement Account prior to age 59.5 would incur a 10-percent penalty. If the distribution is used for qualified higher education expenses, it is exempt from the early distribution penalty. However, income tax on the distribution would still need to be paid. Additionally, the income from the IRA distribution would increase your total taxable income and decrease your potential financial aid.
For a ROTH Individual Retirement Account distribution, a similar policy applies. There would be no penalties incurred or income tax due, but the distribution would be considered non-taxed income on the following year’s Free Application for Federal Student Aid form and could potentially decrease your potential financial aid.
Under both of these scenarios, the withdrawal of funds from your traditional or ROTH Individual Retirement Account would increase your total income (taxable and non-taxable). This would increase the amount of your Expected Family Contribution and could decrease the amount of aid you might receive.
Liquidating assets at the wrong time
The application bases Expected Family Contribution on income and tax data of the prior-prior year before attending college. This is referred to as the base year. What is the prior-prior year? Rather than looking back just one year at a family’s financial information to determine the contribution number, tax information from two years ago (prior-prior year) is reviewed to determine aid.
That means that the base year now runs from the second half of your child’s high school sophomore year through to the first half of the student’s junior year. Put another way, the base year is the calendar year before a student enters his senior year of high school. Parents who have invested for years in stocks, mutual funds, and other investments who plan to liquidate these assets to pay for college need to take special care of the timing of the sale of these assets. Depending on when assets are sold, this could affect the amount of aid available to your child in future years. Why? Because when an investment is sold, and a capital gain is realized, that gain will be included in the parent’s following year income tax return. That capital gain amount will increase the parent’s earning and thus their contribution number.
Grandparent gifts at the wrong time
It’s nice when a grandparent wants to help her grandchild pay for college. But if a grandparent gives money to a grandchild from a 529 plan at the wrong time, it can have a dramatic impact on the amount of aid a student can receive.
A 529 plan owned by grandparents is a useful college-planning tool. Assets in a grandparent-owned 529 plan are not reported on the Free Application for Federal Student Aid, but some colleges may ask a student to include them in the College Scholarship Service Profile, the financial aid division of the College Board. Research the difference when applying for financial aid.
When a grandparent withdraws funds from a 529 plan to pay for a grandchild’s tuition, that amount is reportable the following year as the student’s non-taxable income on the application. The student’s non-taxable income would increase the amount of his Expected Family Contribution, which could lower the amount of aid available to him. The best advice here is to have open conversations with your child’s grandparents in order to best coordinate timing to maximize financial-aid benefits.
Planning for college costs is an ongoing process. One simple mistake or oversight could ruin years of savings and careful planning. Consult with me, another financial advisor, or your accountant for advice before making a costly mistake.
Anthony N. Corrao is president of wealth management and director of corporate education at Manhattan Ridge Advisors. For more than 25 years, he has helped families towards their financial goals by developing financial, educational, and retirement-planning strategies.
The information is intended for informational purposes only, and is not intended to be a substitute for specific tax, legal or investment advice. Securities offered through First Allied Securities Inc., a registered broker dealer. Member FINRA/SIPC. Advisory services offered through First Allied Advisory Services, a registered investment adviser.
