School aid rules byzantine

Personal Finance

February 20, 2007|By Eileen Ambrose | Eileen Ambrose,Sun Columnist

Filling out financial aid forms is difficult enough, but it can be particularly challenging for today's blended families.

Ask Bill from Elkton.

Bill is divorced and his two daughters live with his ex. He lives with his second wife and her son. He's working on the Free Application for Federal Student Aid form for his stepson. Bill says it looks like his income will be included on his stepson's FAFSA along with the income of the boy's father.

"This seems like a double whammy," he says.

How will the federal government and college financial aid offices consider his income for his two daughters and his stepson? he asks in an e-mail.

Kalman Chany, author of Paying for College Without Going Broke, says the FAFSA can be so confusing for blended families that he includes a section on it in his book under the heading "Soap Opera Digest."

FAFSA requires the income of the custodial parent, in this case the mother, as well as the stepparent, Bill, says Chany. The earnings of the boy's father are not included. (When Bill's daughters fill out the FAFSA, his income won't be included.)

This is for federal aid. Private colleges use different rules for awarding their own money, and might ask about the income of all adults, Chany says.

One step forward, one step back?

Last year's pension law provided a tax perk for those who inherited a 401(k), 403(b) or 457 plan from a parent, sibling or partner. It allowed for children and other nonspouses to roll that money into an Individual Retirement Account and avoid a potentially huge tax bill upfront.

Heirs could then take IRA distributions based on their life expectancy, which could be many years. Only spouses could do this before.

"When the law passed, everyone was so excited," says Theresa Fry, manager of IRA and distribution services for A.G. Edwards Inc.

Now, excitement is being replaced by disappointment as details come out. "It's not as great as we thought it would be," Fry says. "There are stipulations."

The Internal Revenue Service said last month that it's up to employers whether to offer such rollovers to nonspouse beneficiaries. If an employer elects not to, then the beneficiary would be required to take a payout in a lump sum or, in some cases, over five years, Fry says.

Of course, employees can lobby an employer to permit these IRA rollovers for nonspouse beneficiaries.

But Martha Priddy Patterson, a director with Deloitte Consulting in Washington, says that might not help. Many employers will be reluctant to offer nonspouse rollovers for fear of lawsuits if heirs fight over 401(k) money, she says.

"Once you roll over the money, it's gone," she says.

Questions? Comments? Write personal.finance@baltsun.com

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