Paying for college after a divorce

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Q. I have two children. I am the custodial parent for my daughter and the non-custodial parent for my son. I am paying 100 percent of my custodial child’s college because my ex is not willing to contribute. I may also be on the hook for my non-custodial child. I took his mother to court to try to get an order for her to contribute, but 529 money has to be depleted before contributions are imposed. I’ve saved in a 529, but probably not enough. Would prepaying all four years be an option and eliminate potential spikes in his college costs?
— Paying out

A. There’s quite a bit to unpack in your questions, so let’s take it a step at a time.

College-bound students determine their eligibility for federal financial aid by filling out the Free Application for Federal Student Aid (FAFSA), on which they must list their own and their parents’ income and assets, said Gene McGovern of McGovern Financial Advisors in Westfield.

He said information from the FAFSA is used to determine what’s known as the Expected Family Contribution (EFC), which is the amount the student and his or her family are expected to contribute toward that year’s cost of attendance at college.

“If the cost of attendance at college exceeds the EFC, federal student aid may be available to make up the difference,” McGovern said. “That aid includes various grants, loans, and work-study opportunities.”

Some colleges also make scholarship awards from their own funds, based on the CSS/Financial Aid PROFILE, which considers more types of assets than the FAFSA.

If parents are separated or divorced, the custodial parent is responsible for filing the FAFSA, McGovern said.

“For FAFSA purposes, the federal government does not count the income or assets of the noncustodial parent in determining a student’s financial need,” he said. “However, any alimony or child support paid by the noncustodial parent must be included on the FAFSA.”

Complicating things further, many private colleges using the CSS/Financial Aid PROFILE do require information from the noncustodial parent, which can affect the amount of aid awarded by the school, but not federal or state aid, McGovern said.

Note that the definition of custodial parent for FAFSA purposes is generally the parent with whom the student lived the most during the past 12 months. This definition can differ from that used for tax or legal purposes, he said.

The EFC is determined by looking at the parents’ and the student’s income, as well as the parents’ and student’s assets.

“On the income side, both students and their parents have what’s known as an income offset or protection allowance, which is a base amount of income that’s not counted toward the EFC,” McGovern said. “Income above those allowances is considered discretionary income, and that’s the amount that’s counted toward the EFC.”

For students, 50 percent of discretionary income is counted, while for parents the percentage varies from 22 to 47 percent based on factors such as family size and the number of family members enrolled in college, McGovern said.

The key here, and what goes to the heart of your question, is that student income includes money received from, or paid on the student’s behalf by, noncustodial parents.

For example, McGovern said, if you, as the noncustodial parent take a $20,000 distribution from your 529 plan to pay for your son’s freshman year college expenses, that $20,000 is considered to be income to your son in that year, which could reduce his aid award for subsequent years by up to $10,000 (50 percent of the $20,000). That’s true whether you give the money to your son or pay his tuition bill directly to the school.

One potential way to reduce the impact of this problem is to take advantage of the FAFSA timing rules, McGovern said.

Under current FAFSA rules, when making financial aid decisions for an academic year (for example, September 2018 to June 2019), colleges now look at income and tax returns from two years ago (in this example, the 2016 tax return), rather than last year’s (2017) return. This is known as the “prior prior year.”

“Thus, any funds you pay for your son’s education expenses starting in January of his sophomore year or later likely won’t be listed or considered as income to your son in any FAFSA, assuming he graduates in four years (and isn’t going directly to graduate school),” he said.

One way to do defer paying your son’s education costs might be to have him take out federal student loans (if available) to fund his remaining costs over and above the scholarships and merit aid during his first two years of college, McGovern said.

“You could later help him to pay off those loans, meanwhile avoiding any adverse impact on his financial aid amount,” he said. “Paying off his loans might even be offered as an incentive to graduate, or to graduate within four years.”

McGovern said you would have to use non-529 plan funds to pay off the loans because education loans aren’t considered to be qualified education expenses under current rules. 529 plan funds not used for education expenses are not only taxable but are subject to a 10 percent penalty.

“As for prepaying all four years of tuition to avoid spikes in college costs, since your son has already been accepted at college, you’d have to check with your son’s college to see whether that’s even an option,” he said. “Note that you’d be forgoing any investment return for three years on your 529 plan or other funds by doing so, which could well be more expensive than avoiding potential tuition increases or financial aid decreases.”

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