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How Rose’s mom eliminated her daughter’s ability to qualify for need-based financial aid in 2012 with one phone call

What do I do if my mom retired, cashed out her 401(k) and now my EFC is so high I no longer qualify for financial aid?

Rose (not her real name) called me last week and wanted to know her options for regaining her financial aid after her mother retired and closed her retirement account.  As Rose had learned, when her mother closed her retirement account all of the money that her mother took out of her own retirement account was reflected as income in 2012 and caused Rose to lose all of the need-based financial aid she had received from her college in each of the last two years (approximately $25,000 a year).

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Why did she lose her financial aid?

Rose lost her financial aid for two reasons.  The first reason is because she is still a dependent of her mother so when filling out the Free Application for Federal Student Aid (FAFSA).  Rose has to report the income of her mother as well as her own when completing the FAFSA.  Rose is a dependent because she did not fall into any of the categories that would exclude her from including her mother’s income.

What factors make her a dependent for FAFSA purposes?

On the FAFSA there is a strict definition of who can qualify as an independent student.  A student must be at least 24 years old, married, a graduate or professional student, a veteran, a member of the armed forces, an orphan, a ward of the courts, someone with legal dependents other than a spouse, and emancipated minor or someone who is homeless or at risk of becoming homeless.   Since Rose did not fit into another of the previous categories that would allow her to claim independent status, Rose’s mom must report the income from her retirement plan as income on her tax return.

What’s the other reason why Rose lost her financial aid?

The other reason why Rose lost her financial aid is tied to the first reason.  Since she does not qualify as an independent student, she must report both her own and her mother’s income.  When her mother closed her retirement account, all the money that was in the retirement fund got reported as income in one year – 2012 – on the tax return.

Let me give you an example to explain the point.  According to the US Census, the average 50 year old has $43,797 in their retirement account.  If we fast forward 12 years to age 62 (average age at retirement), that retirement account balance has increased to about $100,000.  If Rose’s mom took out the entire amount, it would increase her income $100,000.  That $100,000 is over the wages she earned prior to retiring.

In the simplified example, the extra $100,000 of income plus a half year’s wages will increase Rose’s Expected Family Contribution (EFC) to $25,929.1

 

Wages (1/2 year)                                                $ 25,000

Retirement Plan Distribution                        $100,000

Total Income (2012)                                         $125,000

 How Rose’s mom eliminated her daughter’s ability to qualify for need-based financial aid in 2012 with one phone call

For the last 2 years Rose has been attending a private college and receiving approximately $25,000 in need-based grants each year.  When her mother closed her retirement account and took all the money at one time, Rose’s EFC increased by the same amount as she used to receive in financial aid.  Thus, Rose no longer qualified for the $25,000 grant based on need.  Because her mom now had more money at the disposal, the EFC calculation calculates that she should contribute more for her daughter’s education.

Can’t something be done to fix this situation?

 The short answer is maybe.  Rose could approach her financial aid office and ask them to use professional judgment.  Professional judgment is a case-by-case evaluation of a student’s situation to see if adjustments can or should be made.  In this case, Rose had already approached her college’s financial aid office to try and get them to ignore the significant jump in her EFC from previous year to no avail.  Rose’s approach had been to plead her case by saying her mother did not know the impact closing her retirement account would have on her daughter’s EFC.

When asking a college to use professional judgment, “I did not know and made a mistake ” is generally not a compelling reason for a college to set aside an additional $100,000 of income.  A successful professional judgment appeal will generally be based on facts, real numbers with appropriate documentation (W-2, medical bills, layoff notice) to support the request for more financial aid.  It is in your interest to be polite and determined but not obnoxious.

What’s the moral of the story

As a person who likes happy endings, I was frustrated to have had the conversation with Rose after the fact.  My strongest recommendation is while in college or in the year before applying to college that you ask questions of the financial aid officer at the college you’re interested to ensure you don’t find yourself in a similar unfavorable situation especially if you know of an upcoming significant change in your financial situation.

Rose can and should ask her college’s financial aid office to look at her situation again.  I would suggest that she mention that the distribution from her mother’s retirement account was a one-time event. I would also suggest mentioning that her mother’s income is significantly reduced because her mother is no longer working. Any other factors that Rose could add that would support her situation should also be included with all the documentation to support her appeal.

Will it work, maybe. But at least now both you and Rose know that retirement plan distributions while in college can create a situation where you no longer will qualify for financial aid.

1. Source:  http://www.stratagee.com/resources/efc_quick_reference/1213_efc_quick_reference.html

P.S.  If you are a financial aid wizard, you realize my example makes several major assumptions and does not consider things like the age of the oldest parent and the income allowance.  I know that, but trying to explain those two elements within this article would have lengthened it considerably as I would have put my readers to sleep with all necessary caveats and exceptions.  Forgive me for that.

P.P.S. Next week I’ll cover 5 other options Rose can pursue to stay in school.

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