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My primary concern is, merit/need aid is ultimately at their discretion so are they likely to reduce aid if I'm maxing out my 401k?

Merit and need-based aid are different animals. Merit aid awards don't look at your finances, they are just based on merit.

I have never heard of any school doing what you are concerned about. They do add the retirement contribution back to your income for the year in question, but I have never heard of them looking at other years. FAFSA doesn't ask about retirement account balances.

Also, note that most schools do not guarantee to meet financial need, so even if your EFC is less than the cost, you may not get any need-based aid. The schools that do meet financial need are elite private schools and require the CSS/Profile in addition to FAFSA. CSS/Profile does ask about retirement accounts, and private schools that use CSS/Profile can do whatever they want, but from what I have read they do not use the balance in retirement accounts to determine financial need.

Lot's of things in the financial aid game are murky but I decided to keep contributing to my retirement accounts while my kids are in college. The importance of having assets for retirement and the shielding of those assets from the aid formulas made it an easy choice for me.
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