Financial Aid Alert
Volume 3 Issue 4: Spring, 1998
One of the hottest financial topics in America today is the Roth IRA. Much of the discussion concerns converting (rolling over) a regular IRA to a Roth IRA. There have been numerous articles written on this subject, most attempting to address all the financial consequences of a Roth IRA rollover. However, few, if any, have addressed the "financial aid" consequences of a Roth rollover. In many cases though, the effect that a Roth rollover has on a family’s ability to qualify for college financial aid is actually greater than the income tax effect.
To illustrate this effect, consider the following case study:
A taxpayer is considering rolling over $100,000 from a regular IRA to a Roth IRA in the year 1998. The taxpayer’s Adjusted Gross Income (AGI) is $75,000. Since this income is below the $100,000 Roth threshold for AGI and the $100,000 distribution is 100% taxable, the taxpayer is eligible to spread this distribution over the next four years. Therefore, an additional $25,000 in income will be included in AGI over the next four years.
The taxpayer has three children, one of which is a student graduating from high school in 1999 who intends to enroll in a private college as a freshman. The cost of this private college is $22,000 (the average cost of a private college during the 1998-99 academic year).
The four major factors which effect the student’s ability to qualify for financial aid are:
Parent Income
Parent Assets
Student Income
Student Assets
To simplify this case study, it is assumed the parents have no assessable assets and the student has no assessable income or assets. Only the parental income will be considered.
The potential financial aid consequences of this $100,000 rollover to a Roth IRA are as follows:
1. The $25,000 increase in AGI will cause a potential loss of $7,600 in financial aid eligibility. Since, the student is attending a private college, this $7,600 loss could consist of 80% gift-aid (grants or scholarships). Therefore, this particular student could potentially lose $6,080 (80% x $7,600) per year in free money due to the Roth rollover.
2. The taxpayer will also be ineligible for the HOPE Scholarship and Lifetime Learning Credit over each of the next four years. The additional income generated from the Roth rollover will put the taxpayer over the phaseout limits for these credits. The combined potential loss here is $5,000 in tax credits, increasing the potential out-of-pocket loss to $11,080. In some cases, the increased income may also disqualify the taxpayer from the new student loan interest deduction.
3. Many private industry scholarships are also based on income and the taxpayer may be disqualified from receiving this type of financial aid, entirely due to inflated AGI caused by the Roth rollover.
Given today’s high cost of college, the financial advisor must be aware of both the financial aid and tax consequences of a Roth IRA rollover. The timing of this rollover can dramatically effect the family’s ability to qualify for financial aid during college years. It may make more sense to consider a rollover in years which will not effect the student’s eligibility.
About the Author
Rick Darvis is the owner of Darvis Accounting, Inc. of Plentywood. Rick is also recognized as one of the leading experts in the college financial field and for the past four years he has provided accountants and guidance counselors with college financial aid training and consulting services. He is the author of books and software on regarding the college financial aid system. He has also been a guest speaker on the subject of college financial aid at the Montana and North Dakota, Iowa and New York CPA conventions. In addition, he is a Provider of CPE for Practitioner’s Publishing Co. and Western CPE.
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