ACA, FAFSA, and AGI

[phildonnia]

Hello, I was wondering if I could get some advice.  DW and I typically come up with crazy plans to save on taxes or whatever in the last days of the year, and we end up scrambling to do something "creative" in a big hurry, that may or may not always work.  This one is too big not to pass by some other people.  We will be talking with our financial advisor as well (but not until December), but I wanted to see if anyone else has any ideas.

I'm retired two years; DW still working, making $80k plus health plan, but not enjoying it any more.  She also has 6 months accrued vacation, which can be taken as vacation or as a lump sum payment. We have one kid going to college next year, and we're only just now trying to figure out how to pay for it.  Two more kids will be college age in 3 years.  We have $100k in a 529 education plan.  We also want to find health care for after DW quits.  Retirement accounts are fat enough, but I won't be 59 for six more years.

We have $1.5M in non-qualified investments, generating about $65k/yr in dividends (it varies widely and unpredictably). Unrealized gain is about $90k.  So AGI is around $150k.  Household expenses are about $35k, not including taxes, health care, and extraordinary costs.

Here's the thing: to qualify for FAFSA two years from now, we need an AGI less than $65k today (it looks back two years).  And to qualify for ACA two years from now we need and AGI less than $75k.  So we need to 1) reduce our taxable income to that level; 2) continue to have unrealized growth; 3) have money to spend on life, health plan, and a few years of college.  This would save us about $20k a year on health coverage and potentially $50k a year on college expenses starting in two years.

So... the plan is

• cash out our entire $1.5M non-qualified investments in 2023, and take the big tax hit.
• put half of that money in a 7-year CD at 4.4%, with the interest payable at the end of the term; and hopefully not included in income.
• put the other half in a savings account at 5% (which can and probably will change), and live off the interest, or dig into the principal as necessary.  Income from this is more predictable.
• DW quits in January, either taking the vacation payment, or (if they allow) continuing to be nominally employed and covered by health plan, but on vacation
• If somehow we run through it all or there's an emergency, take distributions from Roth contribution basis.
• Get through seven years at <$65k AGI, until I turn 59 and kids are out of college.

Now, this makes me nervous, because we literally came up with this plan at 2am last night, and it that seems like insufficient reflection time for a move of this magnitude. 

Most importantly, the FAFSA AGI limit is a hard threshold.  One dollar over the limit means we have to disclose our assets, which would disqualify us from any financial aid.  And I always seem to get surprise taxable income statements which screw up my plans. Converting our taxable investments to a CD is intended to make this more predictable and regular.  But I've always thought of putting large amounts of cash in CDs and bank accounts as bad investing. 

Any obvious or not-so-obvious ways in which this plan sucks?  Any other thoughts?

[lhamo]

I don't understand how you are going to get under the FAFSA limit two years out if your DW has already been working and earning her 80k salary this year.  That door is basically closed already.  Moving forward, the issue is the dividends in the taxable accounts, not unrealized gains -- if you can get the on paper taxable income down to below FAFSA/ACA thresholds then you will not have to report non-retirement assets.

What kinds of funds are kicking off the dividends?  If they are Vanguard funds, I think the huge dividend payouts they threw off a couple of years ago won't happen again -- they really pissed a lot of people off with the moves they made that resulted in that happening.

I personally would NOT sell off everything in order to try to game the system this way -- seems much too drastic and ill-considered to be worth the savings.  Instead I'd see what moves you could make to reduce the dividend payout as much as possible this year, when you can afford somewhat of a tax hit due to the DW's income.  Anything you can tax loss harvest?  Any positions that tend to pay out higher on the dividend side that you could swap for something else without too much of a tax hit?

Also consider what schools you are applying to.  Some have more liberal income targets for financial aid than the FAFSA would offer.

[phildonnia]

I don't understand how you are going to get under the FAFSA limit two years out if your DW has already been working and earning her 80k salary this year.  That door is basically closed already. 

So, basically, take as much income as possible this year, and have a lean 2024 and beyond.  Either take the vacation payout now in 2023, or if she takes it in 2024 (it's about $40k) then dump it all into a deferred 457(b) and my spousal IRA. 

This is two years out, so, we wouldn't start being eligible for FAFSA until 2026.  But better late than never.

What kinds of funds are kicking off the dividends?  If they are Vanguard funds, I think the huge dividend payouts they threw off a couple of years ago won't happen again -- they really pissed a lot of people off with the moves they made that resulted in that happening.

Two things: we have a collection of private REITs, and these things just randomly decide to close shop usually in November, and send us a pile of capital gain we weren't expecting.  But mostly just mutual funds and that kind of thing.  Nothing from Vanguard, but I guess it's similar.

I personally would NOT sell off everything in order to try to game the system this way -- seems much too drastic and ill-considered to be worth the savings.  Instead I'd see what moves you could make to reduce the dividend payout as much as possible this year, when you can afford somewhat of a tax hit due to the DW's income.  Anything you can tax loss harvest?  Any positions that tend to pay out higher on the dividend side that you could swap for something else without too much of a tax hit?

We're meeting with our advisor tomorrow, where he will probably say the same thing.  We don't have a lot of loss to harvest; plus we usually don't know that we even need to do that until the new year, when it's too late.  So, I'm looking for more predictability really.  It occurred to me that a CD account isn't really that much worse than the markets right now.  "Right now", being the important part I guess.

Also consider what schools you are applying to.  Some have more liberal income targets for financial aid than the FAFSA would offer.

  UC's and private schools.  The private schools all have their own formulas, which will consider our assets in any case.

[secondcor521]

Several of your numbers don't make sense to me.

First, ACA subsidies are available up to 400% of FPL (and even higher through 2025), and the FAFSA exempt from asset reporting limit is 175% of FPL for MFJ.  I don't see how your 400% FPL number can be $75K and your 175% of FPL number can be $65K.

Second, I don't understand how you can have unrealized gains of $90K and then refer to a "huge tax hit".  I read it as having unrealized gains in your taxable account of $90K, and if that's the case, CG on $90K would not strike me as a "huge tax hit" in the world of someone who sounds like a multi-millionaire.

Third, I'd double check your FPL numbers themselves.  Figure out your family size (5?), where you live (CONUS?), and what year FPL numbers to use (2024?).  Note that the FPL breakpoints for FAFSA purposes and the FPL breakpoints for ACA purposes may differ by a year due to the different timing requirements for the two programs.

...

On the strategy front, I'd suggest overall a different strategy:  have your wife retire today, end up with whatever tax return you end up with for 2023, and then file a FAFSA appeal for professional judgment citing the retirement and your lower (presumably) 2024 income.

You haven't given hard numbers, but it sounds to me like the taxes you would pay by cashing out your taxable investments, plus the growth that you would have had on those taxes you're thinking of paying - compounded over the next five to seven years, plus whatever loss in investment gains you're creating by deliberately lowering your investment returns - again compounded over the next five to seven years would possibly exceed any FAFSA benefit you would engineer.  At least try to run the numbers before doing your plan.

As another strategy thought, since you mention the UC system I'm assuming you're in California.  If you have three kids who want to go to college and you've either not prepared for that or are not willing to use your assets to pay for their college, then I'd strongly suggest essentially informing them of this and suggesting they consider the community college route for the first two years, then transfer to one of the in state schools.  From what I've read over the years, California has put some good guardrails in place to help ensure that kids who do two years in CC and finish at a state school will stay on track to graduate.  I've also heard that CCs in CA are a lot cheaper than the state schools.

You can also start, although it's a bit late for some, on all the other strategies to save on college - careful school choice, careful choice of majors/degree programs, scholarships, grants, tax credits like AOTC/LLC, AP/CLEP/IB/concurrent credits, part time work, gap year plus full time work, WUE, 529 state tax credits, being an RA, etc.

[Shuchong]

The part of this plan where you take 1.5 million out of the market and put in in savings and CDs sounds like a really bad idea to me.  That money is presumably in the market for a reason -- likely that it represents a huge chunk of the money you hope to use during a long retirement -- and by taking it out you're taking a tax hit early and missing out on years of time in the market.

Perhaps the better plan is to sell the REITs or whatever else is causing those huge dividends and make the 1.5 million more tax efficient.  I had a bit more than 1.5 million in a taxable account in 2022 (mainly in total stock market and S&P 500 index funds), and had 22k in taxable dividends.  Tax loss harvesting meant I had a 3k capital loss.  This indicates to me that an AGI below 65k is entirely doable without taking the drastic step of getting out of the market.

Also, when you sit down with your financial advisor, perhaps you can talk about essentially shifting the dividend-heavy investments to tax-advantage accounts.  If you really like REITs, buy a REIT fund in your 401k for example, and sell in taxable.  That way, your overall asset allocation doesn't change much, but you end up with far less in taxable dividends.  You may also be able to tax loss harvest by doing this (sell a fund that is down in taxable, buy a similar but not identical fund in tax-advantaged, thus generating capital loss without changing asset allocation).       

I like the overall plan though, of your wife retiring since she no longer enjoys her job, setting you up for lower income as your kids go to college.  (This assumes, of course, that you can comfortably retire based on what you have saved up now, but it sounds like that is not something you're worried about.)

[phildonnia]

Thanks for the feedback, all.

My advisor indeed didn't like the idea of CDs as a long-term investment for such a large amount of money.  But he suggested that we put it all in ETFs, which pay regular dividends, and never ever have capital gain distributions unless we want them to.  That seems like it might help with the predictability problems we have; limits our realized income; and still allows unrealized growth.

Unfortunately, the REITs are not publicly traded, so it seems that we can't get out of them.  The dividends are fairly small, and this can be managed.  We would always be worried that they would suddenly decide to cash out with a few months warning, and push our AGI where we don't want it to be.

Another flaw in my plan was that long-term CDs may not be taxed the way I thought.  Even if you don't get any interest until term end, you might still get a 1099 with imputed interest every year.  I called at least two banks to ask about this, and they assured me that, no, you don't get any interest or statement of interest until the end of the term.  But this was from some temp on the phone who isn't going to be there when I try to explain it to the IRS.  Does anyone know exactly how this works?

The (modified) plan is to sell $1M in mutual funds right now, and get a capital gain in 2023.  (My earlier figures were wrong; there is a $180k gain here).  That will at least get us set up to have low income in 2024, whatever we decide to do.  If we still want to back out of the whole plan, we can just jump back in to the same funds.  Otherwise, we can invest in the ETFs.  DW will quit in early 2024, and take a $40k payment for vacation time.  This will go into a pre-tax 457(b), and a pre-tax spousal IRA.  So, we'll have a small amount of dividends from the REITs and some more from interest on deposit accounts.  And then hope that the REITs behave themselves.  They allegedly have only $40k in gain, but since they're not publicly traded, that may be wildly inaccurate as to an actual liquidation.

Just have to mention: The total savings for financial aid and health care subsidies is potentially $300k over the next seven years.  But without it, we're not ruined.  We can pay for college, and we can pay for health care, and our tax-deferred accounts are doing fine.  And if we try this plan and it doesn't work, or we miss the next market boom, we're still okay there too.

I'll update this "case study" as things progress.

[lhamo]

Re: taxes on CD interest, it probably depends on the terms of the CD and whether the interest is paid out monthly or quarterly during the life of the CD or all saved up and paid out all at the end. 

Bankrate.com says the interest is taxable when the interest is actually paid:

https://www.bankrate.com/banking/cds/paying-tax-on-cd-interest/

Glad you were able to figure out a strategy that will most likely work!  I was always a bit skeptical about whether we would end up with financial aid given our asset base, but was pleasantly surprised when things worked out as predicted and we hit a $0 EFC last year.  Saves us 30k/year.

[moneymatters242]

DW and I typically come up with crazy plans to save on taxes or whatever in the last days of the year, and we end up scrambling to do something "creative" in a big hurry, that may or may not always work.

Your and DW's "crazy plan" has piqued my interest.  It does sound crazy - crazy like a fox!

I'll be in a similar situation some years ahead, and qualifying for the FAFSA simplified needs test had not previously occurred to me.  It looks like a possibility after reading up.

But one point I'm confused about - you mentioned needing to keep under <$65K AGI for 7 years.  But doesn't the simplified needs test rule that allows you to avoid disclosing assets require <$50K AGI?  Trying to understand if I'm missing something.  That $15K difference would be a pretty significant difference for whether we could make this happen.

[secondcor521]

DW and I typically come up with crazy plans to save on taxes or whatever in the last days of the year, and we end up scrambling to do something "creative" in a big hurry, that may or may not always work.

Your and DW's "crazy plan" has piqued my interest.  It does sound crazy - crazy like a fox!

I'll be in a similar situation some years ahead, and qualifying for the FAFSA simplified needs test had not previously occurred to me.  It looks like a possibility after reading up.

But one point I'm confused about - you mentioned needing to keep under <$65K AGI for 7 years.  But doesn't the simplified needs test rule that allows you to avoid disclosing assets require <$50K AGI?  Trying to understand if I'm missing something.  That $15K difference would be a pretty significant difference for whether we could make this happen.

FAFSA is being revamped now (ish).  You should learn the new rules, because they're different from the old / existing rules.

Under the old rules, it was $50K or $60K plus not filing certain IRS schedules on your taxes and was called "simplified needs test".

Under the new rules, it's 175% (or 225% if single/HOH) of FPL for your family size (which is generally approxiately the same definition as for ACA).  *Or* anyone in the family being on a federal needs based program (like Medicaid).  The new term for this is "exempt from asset reporting".

The new rules are called "FAFSA simplification" because they reduced the number of questions needed to be answered on the FAFSA.  There aren't too many articles about FAFSA simplification and even fewer on being exempt from asset reporting.  I read the text of the law.  You might be able to find some bill summaries that talk about it a bit.

[moneymatters242]

Under the new rules, it's 175% (or 225% if single/HOH) of FPL for your family size (which is generally approxiately the same definition as for ACA).  *Or* anyone in the family being on a federal needs based program (like Medicaid).  The new term for this is "exempt from asset reporting".

The new rules are called "FAFSA simplification" because they reduced the number of questions needed to be answered on the FAFSA.  There aren't too many articles about FAFSA simplification and even fewer on being exempt from asset reporting.  I read the text of the law.  You might be able to find some bill summaries that talk about it a bit.

Great information.  Thanks for sharing.

[phildonnia]

Under the new rules, it's 175% (or 225% if single/HOH) of FPL for your family size (which is generally approxiately the same definition as for ACA).  *Or* anyone in the family being on a federal needs based program (like Medicaid).  The new term for this is "exempt from asset reporting".

One weird twist here: the law says being on a federal needs-based program in the last 24 months; but the questionnaire considers the previous two calendar years.  Since we just signed the kids up for Medicaid in January, you can see this makes a big difference.  Not sure whom to complain to though.

[secondcor521]

Under the new rules, it's 175% (or 225% if single/HOH) of FPL for your family size (which is generally approxiately the same definition as for ACA).  *Or* anyone in the family being on a federal needs based program (like Medicaid).  The new term for this is "exempt from asset reporting".

One weird twist here: the law says being on a federal needs-based program in the last 24 months; but the questionnaire considers the previous two calendar years.  Since we just signed the kids up for Medicaid in January, you can see this makes a big difference.  Not sure whom to complain to though.

Is that the old questionnaire or the new one?  Could be a difference between old FAFSA and new FAFSA, or an issue due to the changes related to FAFSA simplification.

I'd call the FAFSA folks in the US Department of Education and ask.  Or read the text of the law and then answer the question according to the law.  With the old FAFSA, there used to be explanations for specific questions to help clarify them; I don't know if such exists with the new FAFSA yet, or if it ever will - would be nice to have, though.

[aspiring]

The simplified needs test was eliminated as of the 2024-25 FAFSA. You will need to report all non-retirement assets. 1.5 million in a CD would need to be reported as a cash asset (and will obviously reduce or more likely eliminate any aid).

Move what you can to retirement accounts. Everything else is reported and weighed against your ability to pay for college. It seems you will be able to afford tuition at most schools.

[secondcor521]

The simplified needs test was eliminated as of the 2024-25 FAFSA. You will need to report all non-retirement assets. 1.5 million in a CD would need to be reported as a cash asset (and will obviously reduce or more likely eliminate any aid).

Well, yes, technically SNT is gone.  But it was replaced/renamed by a very similar concept called "exempt from asset reporting" (EFAR).  People who meet the qualifications for EFAR would not need to answer any FAFSA questions about either parental or student assets.  They could have a $1.5M CD in a taxable account and legally and properly not disclose that information to FAFSA.  Their FAFSA SAI would only be based on parental and student income.

Personally, having read about SNT and EFAR, I think the latter is actually easier to qualify for because there are more ways to qualify.

As I've mentioned before, there isn't much written about EFAR because the new FAFSA is still relatively new, and EFAR only applies to a possibly small subset of families.

[lhamo]

The simplified needs test was eliminated as of the 2024-25 FAFSA. You will need to report all non-retirement assets. 1.5 million in a CD would need to be reported as a cash asset (and will obviously reduce or more likely eliminate any aid).

Well, yes, technically SNT is gone.  But it was replaced/renamed by a very similar concept called "exempt from asset reporting" (EFAR).  People who meet the qualifications for EFAR would not need to answer any FAFSA questions about either parental or student assets.  They could have a $1.5M CD in a taxable account and legally and properly not disclose that information to FAFSA.  Their FAFSA SAI would only be based on parental and student income.

Personally, having read about SNT and EFAR, I think the latter is actually easier to qualify for because there are more ways to qualify.

As I've mentioned before, there isn't much written about EFAR because the new FAFSA is still relatively new, and EFAR only applies to a possibly small subset of families.

Can verify this.  Completed the FAFSA this weekend.  Because we could answer "yes" to the benefits question (we qualify for Medicaid based on low taxable income) we were only asked to provide electronic access to our tax returns.  Didn't have to report any of our other assets.

[phildonnia]

The simplified needs test was eliminated as of the 2024-25 FAFSA. You will need to report all non-retirement assets. 1.5 million in a CD would need to be reported as a cash asset (and will obviously reduce or more likely eliminate any aid).

Thanks all.  Yes, this is the route we are going: We qualified for and got Medicare, and skipped all the asset questions.

Well, yes, technically SNT is gone.  But it was replaced/renamed by a very similar concept called "exempt from asset reporting" (EFAR).  People who meet the qualifications for EFAR would not need to answer any FAFSA questions about either parental or student assets.  They could have a $1.5M CD in a taxable account and legally and properly not disclose that information to FAFSA.  Their FAFSA SAI would only be based on parental and student income.

Personally, having read about SNT and EFAR, I think the latter is actually easier to qualify for because there are more ways to qualify.

As I've mentioned before, there isn't much written about EFAR because the new FAFSA is still relatively new, and EFAR only applies to a possibly small subset of families.

Can verify this.  Completed the FAFSA this weekend.  Because we could answer "yes" to the benefits question (we qualify for Medicaid based on low taxable income) we were only asked to provide electronic access to our tax returns.  Didn't have to report any of our other assets.