Before you have to pay anything under the repayment options, the government lets you keep 100% of your salary up to a certain amount. That amount is based on what the income guideline is for 150% of the poverty level for your family size. The poverty guidelines are updated periodically in the Federal Register by the U.S. Department of Health and Human Services under the authority of 42 U.S.C. 9902(2).
According to the Department of Education, the portion of your income that equals 150 percent of the poverty guideline for your family size is considered non-discretionary.
2017 Poverty Guidelines for the 48 Contiguous States and the District of Columbia
How to Calculate Discretionary Income
For the purposes of your student loan payments, your discretionary income is every dollar (pre-tax) that you make above 150 percent of the federal poverty guidelines (the numbers listed on the table). Once you determine your discretionary income, divide that number by 12. The new number is your monthly discretionary income.
Although you can use your last two paystubs to verify your income with your student loan servicer, most borrowers use their most recent income tax form. If you use your most recent tax form, yoru discretionary income will be based upon your Adjusted Gross Income.
Disadvantages of the Department of Educations Discretionary Income Calculation
Unfortuantely the DOE’s calculation of discretionary income does not take into consideration your actual household expenses such as your mortgage or rent, your vehicle payments, medical bills, child support or private student loan debt.
Since discretionary income is based on your adjusted gross income from your 1040, to help lower your student loan payment it is suggested that you investigate ways to lower your adjusted gross income.
As stated above, with the REPAYE program, payments are capped at 10 percent of your discretionary income. Your discretionary income is calculated using your adjusted gross income minus 150 percent of the state poverty guideline for your family size.
Although it’s possible to qualify for a monthly payment of $0, there is also no cap on payments — a major change from the original PAYE and IBR programs. So if your income increases significantly, so could your payments.
Another potential drawback of the REPAYE program is that if you’re married, your spouse’s income and existing federal student loan debt are considered when determining the monthly payment. This is true even if you file taxes separately, although exceptions are made for domestic abuse victims.
When is remaining student loan debt balance forgiven?
Balances for undergraduate degree loans are forgiven after you make 20 years of eligible payments. Balances for graduate and professional degrees, or a combination of graduate and undergraduate degrees, are forgiven after 25 years of eligible payments.
According to the IRS, forgiven student loans are considered taxable income. So if you qualify for student loan forgiveness under REPAYE, plan ahead and prepare for the potential tax bill you will end up with.
If your payment is low the Government will assist in paying interest on loans?
Another concern with any income-driven plan is the fact that your interest can keep accruing at a faster rate than you pay down your balance. With REPAYE, though, you have a bit of relief through the federal loan interest subsidy.
If your monthly payment is so low that it doesn’t cover the monthly interest charges, any excess interest on subsidized loans will be paid by the Department of Education for up to three years. After that time period, the Department of Education will cover 50 percent of unpaid interest.
The government also covers 50 percent of accrued interest charges on unsubsidized loans throughout the REPAYE repayment period.
If you leave the REPAYE program, interest will capitalize. That means it will be added to your balance and you will have to repay that amount as part of your loan.
Tax season is obviously important for a number of reasons, but few people realize the tremendous impact that your tax return can have on your yearly student loan payments. Each year, borrowers enrolled in the IBR (Income-Based Repayment) and PAYE (Pay As You Earn) repayment plans, must submit evidence of their yearly income.
Most people use their most recent tax return as evidence of their income. The loan servicer calculates your required payment based upon your AGI (Adjusted Gross Income). Therefore, the lower your AGI, the lower your required minimum student loan payments will be for the following year, assuming you are on REPAYE, IBR or PAYE.
How do I Lower My Adjusted Gross Income
Tax breaks that lower your AGI are commonly known as Above-the-line deductions. With each above-the-line deduction that you get credit for, your AGI is lowered, and in turn your monthly student loan payment is lowered.
Here are a few examples:
Contributions to a Traditional IRA
Interest paid on student loans (this would include private student loans)
Health Savings Account contributions
Certain moving expenses
A Special Consideration for Married People
If you are married and on the REPAYE, IBR or PAYE payment plans, it is very important to consider about your student loans when you do your taxes. If you file as married filing separately, your spouses income will not be considered when calculating your monthly student loan payments. However, by filing jointly, you will qualify for tax breaks especially for couples. As a result of these competing interests, it is critical to do the math and weigh the pros and cons of each option.
If you are unsure about starting a traditional IRA and wondering whether or not you can afford it, think about it in terms of your student loans AND your taxes. Putting some money away in that IRA not only will lower your taxes, but it will also lower your monthly student loan payments.