College Planning for Divorced Families
The combination of stress, financial strain, unemployment, illness, and homeschooling children has put a significant strain on relationships during the current pandemic. Practically every aspect of getting a divorce has become much more challenging due to COVID-19. When parents divorce, a big concern is the children and how to pay college expenses. With college costs continuing to rise every year, if the family and college-bound student plans to apply for financial aid, then some specific issues need to be addressed before completing the FAFSA® and CSS PROFILE® financial aid applications.
DIVORCED OR SEPARATED PARENTS
If the parents are divorced or separated, the income and asset information of the parent with whom the student lived the most in the previous twelve months must be listed, regardless of which aid application you file; however, whether or not the non-custodial parents income and assets are included will vary significantly from one aid application to the next.
A "separation" need not be a legal separation. The student’s parents may consider themselves separated when one of the parents has left the household for some time and no longer makes a substantial contribution to the finances of the household.
If the student did not live with one parent more than with the other (as in the cases of joint custody or a married couple who divorced or separated immediately before the financial aid application was signed), the income and asset information of the parent who provided the majority of financial support during the previous twelve months should be used. However, this may not be the parent who claimed the student on a tax return, or the parent who was awarded custody by a court order. And in this case, "financial support" includes money, gifts, loans, housing, food, clothes, car, medical and dental care, payment of college costs, etc.
On September 15, 2020, a married couple was divorced. On October 1, 2020, their college-bound child completed a FAFSA financial aid application. For financial aid purposes, the household status is determined as of the date the financial aid application is submitted. Since it was determined that the mother was the custodial parent, in this case, only her income and assets were reported on the financial aid application. Based on their accountant’s advice, the couple had filed a joint tax return for 2018 (FAFSA 2-year look-back). Since only the mother’s income was reported on the financial aid application, she had to separate her income and corresponding income tax liability from the joint income and report it on the financial aid application.
DIVORCE PLANNING STRATEGIES TO CUT THE COST OF COLLEGE
Proper financial aid and tax planning in a divorce can preserve more of the income and assets for both the parents and the children. Here are some areas in divorce planning to consider when planning for college at the same time.
Education Clause of Divorce Settlements
An “education clause” is often included in a divorce settlement. These clauses require the non-custodial parent to contribute a certain amount of money to the children’s cost of college. Some colleges will treat this contribution as a “resource” of the student. Thus, this non-custodial contribution reduces the child’s financial aid eligibility on a dollar-for-dollar basis.
Since alimony is deductible from the gross income of the spouse making the payment and included in the income of the spouse receiving the payment, the deduction for alimony creates an opportunity to shift income from a higher to a lower tax bracket spouse. Payments made to a former spouse that can be considered alimony are medical insurance, mortgage payments, real estate taxes, insurance, utilities, life insurance premiums, and college costs. A divorced client can also use alimony to save for a child’s college education by investing in Roth IRAs. If the client had no earned income, no contribution to a Roth IRA could be made. Since alimony is considered earned income, the alimony payment could be used to fund a Roth IRA. Then during college years, these Roth IRA contributions could be withdrawn income tax-free to pay for college expenses.
If a client intends to remarry after a divorce or the death of a spouse, the use of a prenuptial agreement should be considered. Such an agreement can be used to preserve the funds established for future college costs for children from a prior marriage. Absent a prenuptial agreement, the ownership and disposition of property in future divorce proceedings will be determined by state courts. The court decision may be contrary to the original intention of using the assets to fund the future college costs of the children or stepchildren
Practically every aspect of getting a divorce has become much more challenging due to COVID-19. Most married families with high income and assets will not qualify for need-based financial aid. However, once the parents become divorced or separated, the student could become eligible for considerable financial, so having a plan to understand the impacts of a family's divorce on college is critical to making sure you maximize the aid your student will receive.
Mike Bink, AAMS®, CCFS®
Mike works with families to simplify the college funding process and is widely recognized as an expert in college planning. He is passionate about empowering families to become informed consumers of higher education so that they don't pay a penny more for college than they absolutely have to.