How Your Retirement Accounts Affect Your Child's FAFSA

The FAFSA Asset Rules: What Counts and What Does Not

The FAFSA uses a formula called the Student Aid Index (SAI) to estimate how much a family can contribute to college costs. The SAI drives financial aid eligibility at most institutions.

Assets counted in the SAI (for dependent students, parent assets): - Taxable investment accounts (brokerage accounts) - Savings accounts and checking accounts - Certificates of deposit - 529 college savings plans (owned by a parent) - Business equity above certain thresholds

Assets NOT counted: - 401(k), 403(b), 457(b) balances - Traditional IRA and Roth IRA balances - Pension values - Equity in primary residence (for most schools using FAFSA only) - Cash value in life insurance policies

This is the most common misunderstanding I saw in practice: parents who had built $400,000 in 401(k)s assumed that balance hurt their aid eligibility. It does not — unless they withdraw it.

The Trap: Retirement Distributions Count as Income

Here's where many families get caught: the balances are excluded, but distributions are income.

The FAFSA uses income from two years prior (the 'base year'). If a parent takes a $40,000 IRA distribution in 2024, that $40,000 appears as income on the 2026-27 FAFSA. At a 22% assessment rate on parent income above the income protection allowance, that $40,000 withdrawal could reduce financial aid eligibility by approximately $2,500-$4,500 per year — every year the student is enrolled.

The same applies to Roth conversions. A $50,000 Roth conversion in a FAFSA base year adds $50,000 to reportable income, potentially costing $5,000-$10,000 in aid per year.

Strategic implication: plan large IRA distributions and Roth conversions either before the child starts high school (base year is 2 years before first college enrollment = sophomore year of high school) or after the child's final FAFSA year.

The 529 Owned by a Grandparent: The Old Trap and the New Rule

Until 2024, a 529 account owned by a grandparent created a significant aid penalty. Distributions from grandparent-owned 529s counted as student income on the FAFSA — assessed at 50% versus 22% for parent income. A $20,000 distribution could cost $10,000 in aid.

The FAFSA Simplification Act changed this. Starting with the 2024-25 FAFSA, distributions from grandparent-owned 529s are no longer counted as student income. This removes the old 'superfund' planning strategy that had grandparents waiting until the child's final FAFSA year.

However: grandparent-owned 529 assets may still be reported on some CSS Profile schools (private institutions that use their own financial aid formula in addition to FAFSA). The old rules may still apply at those institutions.

Should You Sacrifice Retirement Savings to Help With College?

I was asked this question regularly. My analysis was consistently: no, retirement savings should not be raided for college costs.

Here's the framework I used: 1. Qualified college loans exist. Qualified retirement loans do not. A student can borrow for education and repay over decades from a rising-income career. You cannot borrow for retirement. 2. Withdrawing $50,000 from a traditional IRA at 55 for tuition costs the 10% penalty ($5,000) plus ordinary income tax (typically $8,500-$12,000). Effective cost: $63,000-$67,000 in pre-tax earnings to deliver $50,000 to a college. 3. The Monte Carlo impact of a $50,000 withdrawal at 55 is not $50,000 — it's roughly $150,000-$200,000 in future portfolio value, depending on years to retirement and assumed returns.

The analysis consistently showed that protecting retirement savings was worth more in lifetime value than the college costs it could replace. The recommendation: maximize contributions to 401k and IRAs (which also reduces FAFSA income), then fund 529s separately.