Impact of Roth Conversions on College Aid

I’d like to convert a traditional IRA to a Roth, but my son will be going to college soon. Will converting the IRA affect our chances of getting financial aid?

It might. Even though IRA balances aren’t counted as assets in the federal financial-aid formula, converting a traditional IRA to a Roth could affect your financial-aid award because the money you convert will increase your taxable income for the year.

If you plan to apply for financial aid in the next few years, you may want to time your Roth conversion carefully, warns IRA expert Ed Slott. If your child is a high school senior, this year’s financial-aid application is unaffected because it reflects your 2009 income, But when you file for financial aid next year, a 2010 conversion could have an impact. Even if your child is a sophomore or a junior, a conversion in 2010 could affect your college-aid award if you take advantage of the opportunity to spread the tax bill for the conversion over 2011 and 2012.

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If you decide to make the conversion anyway, contact the financial-aid administrators at the colleges to which your child is applying and explain that your income looks unusually high because you converted a traditional IRA to a Roth. Although there isn’t a space on the Free Application for Federal Student Aid (FAFSA) to note the Roth conversion, aid administrators are allowed to use their professional judgment to decide whether or not to count the conversion in your income, says Haley Chitty, spokesman for the National Association of Student Financial Aid Administrators. “It’s important for families to make sure that the financial-aid office is aware of it,” he says. “Different schools will handle it differently.”

Chitty recommends contacting the colleges to explain your situation as soon as your FAFSA has been processed and you’ve received your federal student-aid report, rather than waiting until you get your aid award from the college. “Some may be able to adjust your award upfront, and some may wait until you get your aid award to make any changes,” he says.

If you’ve already converted a traditional IRA to a Roth and you’re worried that the extra 2010 income could cost your family valuable college aid, remember that you can undo the conversion -- basically switch the account back to a traditional IRA -- any time before you file your 2010 tax return next spring. Doing so will eliminate the conversion income so you don’t have to report it on your student aid application.

For more information about Roth IRA conversions, see our Roth Conversions for Everyone special report. Also see our Paying for College special report for information about saving and paying for college.

As the "Ask Kim" columnist for Kiplinger's Personal Finance, Lankford receives hundreds of personal finance questions from readers every month. She is the author of Rescue Your Financial Life (McGraw-Hill, 2003), The Insurance Maze: How You Can Save Money on Insurance -- and Still Get the Coverage You Need (Kaplan, 2006), Kiplinger's Ask Kim for Money Smart Solutions (Kaplan, 2007) and The Kiplinger/BBB Personal Finance Guide for Military Families. She is frequently featured as a financial expert on television and radio, including NBC's Today Show, CNN, CNBC and National Public Radio.