If you have a junior or senior in high school, or a child who is currently in college, and they
will also be attending college in the fall of 2016 or later… this one mistake could cost you big on financial aid.
As I discussed in a previous article, your 2015 Federal Income Taxes will be used to fill out both the January 2016 Free Application for Federal Student Aid (FAFSA), which will help determine financial aid for the 2016-2017 college year. It will also be used to help fill out the October 2016 FAFSA, to help determine financial aid for the 2017-2018 college year.
This means that between now and the end of 2015, you have a limited chance to try to reduce the income that will be reported on the financial aid forms that most colleges require. That’s not a lot of time. But, if you do it now, you may be able to potentially save your family thousands of dollars in college costs… and in turn receive thousands more in potential aid. If you are one of the many families that will be required to use their 2015 Federal Income Taxes two years in a row, I feel it’s extremely important to be diligent and make the right moves to try and maximize potential financial aid over these next two years.
With that in mind, here’s one potentially big issue:
PROBLEM: THE CAPITAL GAINS MONSTER
Probably the biggest “income” issue, looming for many parents, will be investment capital gains distributions. Unfortunately, capital gains can artificially inflate income. This may be even more counter-productive when applying for financial aid, than it is when doing your taxes. In determining financial aid eligibility, the FAFSA calculation weights income much more heavily than assets. The FAFSA determines how much your family is expected to pay for college, also called the Expected Family Contribution (EFC). In fact, these aid calculations may assess your income much differently, and harshly, than on your federal income taxes. For example, financial aid calculations may penalize you by figuring between 22% and 47% of your income can be used towards paying for your kid’s college (beyond a modest “Income Protection Allowance”). The aid forms even consider items as “income” that your federal tax forms may not!
So, not understanding what the FAFSA counts as income, and then trying to actively reduce it, can result in directly penalizing and reducing your financial aid eligibility by huge chunks. That could mean a significant increase in your total out of pocket college costs.
Fortunately, taking an active role in financial aid planning and college funding can often help reduce the income (and even assets) that are used in calculating your Expected Family Contribution.
SOLUTION: You may have sold investments this year and realized a gain. If so, look to offset them with realized losses. However, that’s not most dangerous scenario… there’s one that may unknowingly sneak up on you without warning. If you own investments in a taxable account, you be may blindsided with large accumulated capital gains distributions this year… in some cases, even if those investments have lost money or you have only owned them for a short period of time! The last few years were, in general, good for investors. Even though this year may not shape up so well, if you are holding investments that have realized big gains this year, it may hurt you on both income taxes and your financial aid eligibility.
Many investments that clients routinely hold in their portfolio will not even issue those capital gains distributions until late this December, which may make it especially difficult to judge. Some investments may provide capital gain estimates, while others will not. So, consider actively trying to offset those estimated distributions with losses elsewhere in your portfolio… maybe even trying to “over” estimate how much you offset them, just to be safe. If you are using a financial planner or advisor to help manage your portfolio, they should be proactive and discuss this with you already.
For this year, you have a limited time left to strategize and actively see if a big difference can be made in the potential financial aid that your student can qualify for over the next two years. Remember, this is a process you should repeat every year that your income and assets will be used to calculate financial aid eligibility. Not doing so could result in paying more in college costs than you need to… which is money wasted. Every dollar that you spend on your children’s college is one less dollar that you have to save for your own retirement.
As always, and whether or not you are a current client, if you have any questions please feel free to contact me.