Does Contributing More to Your 401(k) Lower Your EFC on Your FASFA?

401(k) accounts are retirement plans that allow you to reduce your taxable income by contributing part of your wages to the plan. These elective contributions cut an employee’s taxable income for federal income tax purposes. Though taxable income is a key component in determining your EFC on your FAFSA, taxable income for tax purposes isn’t the same as for FAFSA purposes.

The assets held in a qualified retirement plan, such as a 401(k), play no role in the EFC in a FAFSA. These assets are designated for your retirement, so they aren’t readily available for you or your family even if you need them to pay college expenses. Aside from behind held for retirement, the FAFSA formula recognizes that if you take an early distribution (before you’re age 59 ½) from your 401(k) account, you’ll face a 10 percent tax penalty. If, however, you’re getting retirement money, that will be considered income for FAFSA EFC purposes.

Technically, there are no involuntary contributions forced on employees to their 401(k) plans. Employers may automatically enroll eligible employees and withdraw a certain salary percentage to contribute to the plan. Employees can always opt out of the plan. These contributions are treated the same as voluntary 401(k) contributions for FAFSA purposes.

Basically, all of your contributions to your 401(k) plan will be voluntary. Unfortunately, they won’t lower your EFC. Instead, those voluntary contributions are treated as untaxed income for FAFSA purposes. Untaxed income will increase your FAFSA income, which in turn increases your EFC. The result for you is a smaller amount of financial aid.