Happy New Year, Class of '10! And Welcome to Your College Financial Aid Base Year
As they were ringing in the New Year on January 1, high school
juniors and their parents were also ringing in their college
financial aid "base year." Although the actions taken in the
base year can mean the difference between saving thousands on
college expenses and needlessly overspending, few people
understand what they need to do to achieve the former rather than
suffer the latter. So, let's take a closer look.
If you are like the vast majority of American's in our sagging
economy, your family will be looking for additional funds to help
cover the cost of a college education. The largest share of this
need-based supplemental money comes from the federal government
through its financial aid system.
But the government also assumes that you are able to participate
in the expense of educating your child prior to considering how
and to what level they will participate in funding your child's
education. Therefore, in order to determine your initial level of
participation, families are required to fill out the Free
Application for Federal Student Aid, or FAFSA form.
The FAFSA captures the required financial information used to
calculate how much your family is expected to pay via a formula
known as the Federal Methodology (FM). Your initial or beginning
monetary participation level is known as your Expected Family
The data used to generate the initial EFC calculation is
collected beginning in January of your child's junior year in
high school and ends on December 31 of that same year, which
would be his or her senior year in high school. This time frame
is referred to as your "base year."
In essence, if you're in your base year, you are now under the
financial aid microscope and any financial moves being considered
(including the sale of real estate or stocks, withdrawals from
IRAs, contributions to retirement plans, receiving monetary
gifts, etc.) must be weighed not only from a federal tax
standpoint but also in relation to the financial aid system. The
catch is that what makes sense from a 1040 point of view may have
adverse consequences on your chances of receiving financial aid.
Case in point: Consider contributions made to your 401(K) plan at
work during your child's base year or any year prior to
financial aid application. In order to encourage individuals
saving for retirement, the federal government does not tax
contributions made to 401(K) plans up to a specified annual
limit. This money enters the retirement plan on a pre-tax basis
with taxes being accounted for as money is withdrawn to
The Federal Methodology used to calculate your EFC treats these
contributions from an entirely different prospective. The
financial aid system believes that you can stop contributing
towards retirement and apply these contributions to college
expenses. They anticipate you playing "catch up" with these
contributions after your child is out of school.
Accordingly, your pre-tax retirement contributions, which are not
considered taxable 1040 income, are considered "untaxed income"
by the financial aid system and are added back into the EFC
calculation and assessed at the applicable rate.
If we assume an assessment rate of 30 percent and $10,000 of
retirement contributions, your initial EFC just increased by
$3,000 for the year in which federal aid is applied for. This
could very well eliminate you from being considered for preferred
This is not to suggest that you discontinue your retirement
contributions. However, the harsh reality of the situation is
that the enormity of funding your child's college education and
your retirement collide with each other at an inopportune time,
especially as our national economy struggles. As you make
decisions regarding college education versus retirement funding,
you should carefully weigh how each decision will impact your
wallet, both during the base year and well into the future.
Understanding the pros and cons of any financial moves made
during your base year - or any year in which financial aid is
applied for - from both a tax and financial aid standpoint goes a
long way toward determining what you pay for college. The process
is complicated and should only be done in consultation with a
Marc R. Hill is a financial planner who coaches and educates
families on how to dramatically reduce their college costs up to
$12K or more! Now you can learn how to cut your family's college
costs and protect your retirement account with Hill's FREE
e-newsletter: "College Savings Tip Sheet." Subscribe now for free
at www.reduceyourcollegecosts.info and receive two FREE
issues of Hillís members-only newsletter "Affording College."