The Free Application for Federal Student Aid (FAFSA) determines your eligibility for need-based financial aid for college. In previous years, the FAFSA asked families about the amount they contributed to employer-sponsored retirement accounts like 401(k)s each year, and factored it into households’ overall yearly income, reducing their eligibility for need-based aid.
That’s changing: Under a new rule for the FAFSA form, pre-tax contributions to workplace retirement plans will no longer count as income, which means the potential for greater financial aid. Here’s how families can use this change to prioritize both their retirement savings and budgeting for college costs.
How the new FAFSA rule will impact your retirement planning
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In previous years, the FAFSA asked families to report their retirement contributions, which would factor into their total income. That meant those dollars would reduce their chances for need-based aid. That’s all set to change with a redesigned FAFSA, in which questions about untaxed payments to tax-deferred pension and retirement-savings plans have been removed. These changes are part of the FAFSA Simplification Act passed back in 2020.
This change means that with proper planning, a 401(k) can now provide both retirement security and help increase your eligibility for financial aid, since saving pre-tax through your employer will be a viable way to reduce your total income as reported on the FAFSA. In other words, you may no longer be faced with the strict “either/or” decision to invest in your child’s college or your retirement plan. While some colleges and universities use alternatives to FAFSA, this change will open up more options for many families hoping to strategically leverage their retirement savings.
One way the FAFSA process will be simplified is by drawing more information directly from tax documents. However, the FAFSA collects that tax information from two years prior to the application, so contributing more to retirement accounts this year won’t have an impact on the financial aid awarded for 2024-25 school year—but it will for the 2025-26 year.
The redesigned FAFSA is expected to launch in December 2023 for the 2024-25 academic year. Here’s how you can start prepping now to apply for federal student aid in December.