Over the years, financial planners have gone all-in on Roths. And I get it. Pay the tax now, let the money grow, and pull it out tax-free in retirement? Sounds like a dream. I’ve told plenty of clients the same thing. It is a smart move, most of the time.
But here’s what doesn’t get talked about enough: college is coming.
And if college is approaching and you’re putting money into a Roth 401(k), it is worth checking how that choice fits with the tax years used for aid. It may affect the calculation, but it does not automatically mean you are losing thousands of dollars.
Here’s why: Roth 401(k) contributions do not reduce your taxable wages the way traditional pretax 401(k) contributions generally do. AGI is important to FAFSA, but it is not the entire formula. Aid-year rules, other income, assets, and the school’s own policies all matter.
For the current federal FAFSA, ordinary employee pretax 401(k) deferrals generally reduce the wages included in AGI and are not added back as untaxed income. Deductible IRA contributions and payments to certain self-employed retirement plans are added back. That distinction is why the account and contribution type matter. A change can affect the calculation without guaranteeing a larger award.
Families who save into Roths with good intentions can still be surprised by college costs. Withdrawals from a Roth 401(k) follow different rules from withdrawals of Roth IRA contributions, so check which account you have before planning to tap it. Retirement withdrawals can affect later aid years. A school using the CSS Profile may request additional retirement information and apply its own methodology; ask its aid office before assuming the federal result applies there.
So if college is even remotely on the horizon, within 2 to 5 years, it’s worth rethinking the strategy. This isn’t about beating the system; it’s about understanding how it works.
Want to see how your AGI feeds into the aid formula? Call (781) 471-4310 and we can talk through the tax side. No sales pitch.
James Maguire
Current aid rules: Federal Student Aid’s FAFSA guide. Questions about your family? Explore college planning.
Federal formula reference: Federal Student Aid Handbook: FAFSA income and retirement accounts.