The details of student loans may at first seem hard to grasp, but fully understanding them and the potential benefits they can offer is invaluable. With federal student loan payments set to resume in October 2023, understanding the four distinct income-driven repayment plans and how they may impact you in the long run can help you make the most prudent decision for both your family and your financial plan.
An Overview of the Four Income-Driven Repayment Plans
An income-driven repayment plan is like an adjustment to the way you pay your student loan. It sets your monthly student loan payment at an amount that’s meant to be affordable based on your income and family size. Below are the four types of plans available.
Income-Contingent Repayment (ICR) Plan
The ICR plan is available to borrowers with eligible federal student loans such as Direct Consolidated, Direct PLUS Loans, Direct Stafford Loans, Federal Family Education Stafford Loans, and PLUS Loans (even those made to parents), if consolidated. Monthly payments are calculated each year and are the lesser of 20% of discretionary income or the amount paid on a 12-year repayment plan, adjusted for income.
The ICR plan does not cap its payments, meaning as income increases, so will the payment. Both spouses' incomes are considered if taxes are filed jointly in determining monthly payments. However, if taxes are filed as married filing separately, only the borrower's income is considered. Any balance remaining after 25 years will be forgiven and is potentially subject to taxation.
Income-Based Repayment (IBR) Plan
The IBR plan is available to borrowers with eligible federal student loans such as Direct PLUS loans (PLUS loans made to parents are excluded), Direct Stafford Loans, Direct Consolidated Loans (excluding PLUS Loans made to parents), Federal Family Education Stafford Loans, and PLUS loans. To qualify for the IBR plan, a borrower's debt must be higher than their income. Monthly payments are recalculated each year and capped at 10% of a borrower’s discretionary income for those who received their loans on or after July 1, 2014 and 15% for those who received their loans before that date.
One significant advantage of the IBR plan is that monthly payments will never be more than what would be needed on a 10-year standard repayment plan. In figuring out payments, both spouses' incomes are considered if taxes are filed married filing jointly. If taxes are filed separately, only the borrower's income will be considered. Payments capped at 10% are forgiven after 20 years, and those capped at 25% are forgiven after 25 years. Any amount forgiven after 20 years might be subject to taxation.
Pay As You Earn (PAYE) Repayment Plan
The PAYE plan is available to those with eligible federal student loans such as Direct PLUS loans (PLUS loans made to parents are excluded), Direct Stafford Loans, Direct Consolidated Loans (excluding PLUS Loans made to parents), Federal Family Education Stafford Loans, and PLUS loans, if consolidated (unconsolidated Federal Family Education Stafford Loans do not qualify).
Similar to the IBR plan, one significant advantage of the PAYE plan is that monthly payments, which are recalculated yearly, are capped at 10% of discretionary income and will never be higher than the payment required under a 10-year standard plan. Both spouses' incomes are considered if taxes are filed jointly, but only the borrower's income is considered if taxes are filed separately. Any balance remaining after 20 years is forgiven and potentially subject to taxation.
Revised Pay As You Earn (REPAYE) Repayment Plan
The REPAYE plan is available to borrowers who received Direct PLUS Loans (excluding parents), Direct Consolidated Loans (excludes PLUS loans made to parents), Direct Stafford Loans, as well as Federal Family Education Loans (FFELs) and PLUS loans that have been consolidated (unconsolidated FFELs do not qualify). Payments are calculated annually and are capped at 10% of discretionary income.
Unlike IBR and PAYE plans, monthly payments for REPAYE plans can be higher than required under a 10-year standard payment arrangement. Both spouses' incomes are considered, regardless of tax filing status. A married borrower's income is solely considered if they can prove they are separated from their spouse.
Additional Considerations
Now that we have reviewed the four Income-Driven Repayment options available to those with federal student loans, here are four more things to consider.
- With payments set to resume in 2023, be prepared for changes to your cash flow. Using a budget is an excellent way to organize your spending.
- Individuals employed by a state, federal, or tribal government or not-for-profit organization can receive Public Student Loan Forgiveness (PSLF) after 120 qualifying payments. If you wish to have your loans forgiven under this program, you must work full-time for a qualifying employer, have Direct loans (you can convert your federal loans into a Direct loan), enroll in an Income-Driven Repayment Plan, verify your employment each year, and after 120 qualifying payments, apply to have your loan forgiven. Any amount forgiven under the PSLF program is not subject to taxation.
- Those who expect to have their loan balance forgiven after 20 or 25 years of making payments should be prepared to pay taxes on the amount forgiven. The amount forgiven could be large, so working with a financial advisor to prepare for it is essential. Note: It is always possible that legislation could change, making forgiveness a tax-free event. However, since we cannot predict the future, it is best to plan appropriately.
- Refinancing student loans is also a choice to consider. The decision to refinance might not be for everyone, and navigating the multiple options and complexities of student loans may appear overwhelming. So, we advise you to work with a financial advisor to determine the best strategy for funding your children's education.
There are a lot of things to consider when trying to fund a child’s education (or even your own). How these repayment plans affect your overall finances is much easier to determine with the help of an experienced financial advisor. Reach out today to learn more about how the specialists at Wealth Enhancement Group can help.
