If you're on the hunt for money for college, you need to know the basic ways your income and assets are calculated. These numbers will determine, in large part, whether your student qualifies for loans, scholarships, or even grants.

The term you want to be aware of here is "expected family contribution," or EFC. When you and your student are applying for federal financial aid, your expected family contribution is based on how many people you support, what your last tax documents stated in terms of tax and income, and how many assets you have.

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Federal Student Aid & Taxable Income

Many families don't realize that there are long lists of assets and untaxed benefits that are counted for both federal and institutional financial aid. It might not seem fair, since many of these are tax-deferred or tax-free vehicles, but they're all going to count against you when it comes to the FAFSA form. Here are just a few of the items that count toward your taxable income for college financial aid:

  • Earned Income Credit (EIC)
  • Contributions to pension and savings plans (even tax-deferred ones)
  • IRA deductions
  • Child support received
  • Worker's comp
  • Untaxed IRA distributions, including rollovers
  • Distributions from your retirement fund, even if used to pay for your child's schooling. It counts as taxable income on next year's FAFSA.
  • Investments, including stocks, bonds, mutual funds, and CDs
  • Value of investment real estate (other than your primary residence)
  • Coverdell educational savings account balance
  • 529 college savings plan account balance
  • Qualified tuition program balance

Now, here are a few assets that do not count against you:

  • Life insurance
  • Annuities
  • Retirement funds
  • Value of or equity in your primary place of residence

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How Can Life Insurance Help Pay for College?

Families looking to decrease their taxable income on aid applications are using permanent life insurance to do it. Permanent life insurance includes a cash value account that earns interest (or gains tied to the market) over time. This cash value isn't counted at all in terms of your family's income. But it's possible to pull that cash value out and use it to pay for your child's tuition. Some families choose to sock away money in their permanent life policies so it doesn't count against them on the FAFSA form.

The trick is to balance your financial needs with your expected future needs. You want to sock away enough money to reduce your taxable income, but don't leave yourself without enough money to handle your family's day-to-day responsibilities. It's a tricky balance, but one that's definitely possible to strike.

Of course, it's important not to overlook the most important reason to buy a policy - the financial security and peace of mind it brings your loved ones.

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