Contributions to traditional 401k type plans will now provide a benefit on the Free Application for Federal Student Aid (FAFSA). In the past 401k contributions were still counted as income on the application, therefore limiting the benefits for certain higher income families.
With the recent changes, FAFSA will take the federal taxable income reported on form W-2. Since 401k contributions lower the taxable income on the W-2, families will be able to benefit from 401k deferrals to lower their taxable income when applying for aid. This can create several benefits: lower taxable earnings, increased retirement savings, and less income reported on FAFSA.
Juggling retirement savings and college expenses is always a tough task, but the recent changes to the FAFSA process could help provide an additional incentive to continue funding retirement. In addition, there are often other options available to fund college, such as loans, grants, and scholarships, whereas retirement savings is often funded by your savings rate and time invested.
This change also reflects the advice of many financial advisors which is to avoid jeopardizing retirement plans to fund educational costs. Now there will be more options to plan to fund both goals simultaneously.