The Free Application for Federal Student Aid determines how much financial aid you will receive, not only from the U.S. federal government, but also from your state agency and your school. All of the information you report on the FAFSA affects your financial aid package, for better or worse. The FAFSA handles IRAs differently from most other types of assets, which usually helps improve your financial aid package.
Education IRA accounts, now called Coverdell Education Savings Accounts, do need to be reported on the FAFSA. For dependent students, the FAFSA counts the Coverdell account just like any other parent asset. For independent students, the Coverdell account is a student asset and will have a high impact on financial aid. If the account owner is not related to the student, the account balance does not appear on the FAFSA, but the student needs to report all distributions as untaxed income on the FAFSA the following year.
You do not have to report the balances on your IRA accounts on the FAFSA. This is true regardless of whether you have a traditional IRA, Roth IRA or another type of retirement account, such as a 401k. This is helpful because it allows you to keep your retirement savings for retirement, rather than having to spend them on education for yourself or your children.
You must report all of your contributions to IRAs and other retirement accounts on the FAFSA. If the contributions are not taxable, as is the case with contributions to a traditional IRA or a 401(k), you will report them as untaxed income. Otherwise, you make your contributions out of your AGI, which you report on the FAFSA. Therefore, increasing your contributions to IRAs will not affect your income in ways that will help you qualify for more aid.
Although you are allowed to withdraw money from your IRA without penalty if you use it for education, these funds will affect your financial aid. This is because you must report all IRA distributions taken during the previous year on your FAFSA. Distributions from a traditional IRA are taxed income and are included in your AGI. Distributions from a Roth IRA must be listed as untaxed income on your FAFSA, or as taxed income if you have had the account for less than five years.