As high-school seniors finalize their college applications, parents are sweating over the dreaded Free Application for Federal Financial Aid (FAFSA) form and financial aid applications from the colleges themselves.
Unfortunately, many have probably
missed their best chance to position themselves for the best financial aid
Hey, it’s not your fault.
And we’re here to help, not judge. Because most parents don’t know that the
year most important to determining how much financial aid colleges will give
your child is actually two years before he or she enters those hallowed halls.
So, if your child (like
mine) is a high school sophomore and will be a college freshman in fall 2023,
2021 is the year colleges will use to calculate how much financial aid he or
she will get. For us, it’s showtime!
It’s called the “prior prior year” (PPY) and “is a template, the first base income year they’re going to be looking at,” said Kalman A. Chany, founder and president of Campus Consultants Inc., a New York City-based advisory firm that specializes in financial aid. “No one’s going to be telling you in 10th grade at the high school or the colleges you should be thinking about this now if you want to get the most money.”
Actually, Chany told me in a
telephone interview, “they’re really taking two snapshots in most cases.” One
is the panoramic view of income through a whole calendar year—the prior prior
year. The other is the value of your assets, which they measure whenever you
file your FAFSA form.
So, the key is to do whatever you can
to minimize your income in that PPY, which will be 2021 for families whose
children enter college in fall 2023, and try to lower your financial net worth
before you file that FAFSA form. (There are complicated rules about valuing
assets we’ll get into in a future column.)
That means if you can accelerate income into what’s left of 2020, you can reduce your income for 2021 and improve your child’s chances of getting financial aid. Counterintuitively, paying more taxes next year might help your child get more from the colleges.
“The higher the taxes you pay during a base income year, the lower your family contribution will be,” writes Chany in the 2021 edition of his book, “Paying for College,” published by The Princeton Review. That’s because colleges consider federal income tax payments an expense for financial-aid purposes. But you must balance tax planning with financial aid planning, so please consult your tax adviser.
If you have the wherewithal—a big “if” these days–here are five things you can do to lower your income in the all-important 2021 base income year:
- If you have a bonus coming, try to get it paid and deposited by Dec. 31. Taking it now would increase your income this year and lower it next year when it could help your child get more aid.
Need dental implants,
eyeglasses, therapy or hearing aids? Get them in 2021, because colleges may deduct
significant unreimbursed family medical expenses from income, even if you don’t
have enough to itemize on your federal income taxes.
- But now, not next year, may be the time to sell appreciated securities in a nonretirement account if you’ll need the money, because capital gains you take in the PPY also count as income. You might also consider using appreciated stock or funds to make a big charitable contribution this year, avoiding capital-gains taxes for this year while reducing a potential 2021 deduction that would raise the income colleges look at to calculate aid.
- If you need to withdraw money from a traditional IRA or 401(k), do it now, not next year. “Any IRA withdrawal during a base income year will raise your income in the financial aid formulas, thereby reducing aid eligibility,” writes Chany. The CARES Act allows you to take a penalty-free retirement plan distribution up to $100,000 through Dec. 31 and book all the income this year for tax purposes. Again, check with your tax adviser.
- Max out your 401(k) contribution this year, but skip it next year. Use the remaining pay periods of 2020 to top off your 401(k) contributions, including whatever catch-up contributions you can make. But, Chany writes, “any tax-deductible contribution you make into these plans voluntarily during the base income years is treated just like regular income.” Instead, contribute to your Roth IRA next year because, he says, that’s not considered untaxed income.
Chany stressed that COVID has changed things so much even people making substantial income shouldn’t give up on getting financial aid. “Because it’s now such a deep buyer’s market, people who previously would have been denied aid may well qualify for assistance,” he told me. That’s a rare bit of good news at a time parents aren’t finding very much to celebrate.
Howard R. Gold is a MarketWatch columnist. Follow him on Twitter @howardrgold1. No-Nonsense College appears monthly.