Your Retirement Savings Are Affected by the New FAFSA Rule.

How to apply for need-based financial aid for college? Fill out the Free Application for Federal Student Aid (FAFSA). Previously, the FAFSA inquired annually from families about the amount they contributed to employer-sponsored retirement accounts, such as 401(k)s, and deducted that amount from the household's total annual income, thereby decreasing the household's eligibility for need-based aid.

That is about to change: pre-tax contributions to workplace retirement plans will no longer be considered income under a new FAFSA form rule, potentially increasing financial aid. This shift can help families budget for college expenses and prioritize retirement savings.

Your retirement planning will be affected by the new FAFSA rule.

Families were asked to report their retirement contributions on the FAFSA in prior years, and those reports were added to their total income. This implied that their chances of receiving need-based assistance would be diminished by those dollars. With the release of the revised FAFSA, which does away with questions regarding tax-free contributions to retirement savings and tax-deferred pension plans, all of that is about to change. The FAFSA Simplification Act, which was passed back in 2020, includes these modifications.

As saving pre-tax through your employer will be a practical way to reduce your total income as reported on the FAFSA, this change means that, with careful planning, a 401(k) can now provide both retirement security and help increase your eligibility for financial aid. Stated differently, you might not be forced to make the rigid "either/or" choice between funding your child's college education or your retirement account. Many families hoping to strategically leverage their retirement savings will have more options now that this change has occurred, even though some colleges and universities use alternatives to the FAFSA.

An approach to streamline the FAFSA application process is to extract more data straight from tax records. Donating more to retirement accounts this year won't affect the amount of financial aid awarded for the 2024–25 school year, but it will for the 2025–26 year because the FAFSA gathers that tax information from two years prior to the application.

For the 2024–2025 academic year, the redesigned FAFSA is anticipated to go live in December 2023. Here's how to get ready now so that in December you can submit an application for federal student aid.

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