Category Archives for "Student Loan Planning"

Apr 14

Ways to pay off Parent PLUS loans

By Saki Kurose | Financial Planning , Student Loan Planning

Ways to pay off Parent PLUS loans

Ways to pay off Parent PLUS loans

Introduction

Young adults are not the only ones saddled with the obligation to pay back massive amounts of student loans.  Many parents take out loans in their names to help their children pay for college, and in many cases, these loans are getting in their way of achieving their goals like saving for retirement.  Under the federal student loan system, parents can take out Parent PLUS loans for their dependent undergraduate students. One of the major differences between Parent PLUS loans and the loans that the students take out themselves is that there are fewer repayment options available for Parent PLUS borrowers. Parent PLUS loans are only eligible for the Standard Repayment Plan, the Graduated Repayment Plan, and the Extended Repayment Plan.  However, there are strategies for managing Parent PLUS debt.  When consolidated into a Direct Consolidation Loan, Parent PLUS loans can become eligible for the Income-Contingent Repayment (ICR) plan, in which borrowers pay 20% of their discretionary income for up to 25 years.  Currently, ICR is the only income-driven repayment plan that consolidated loans repaying Parent PLUS loans are eligible for.  However, when a parent borrower consolidates two Direct Consolidation Loans together, the parent can potentially qualify for an even better repayment plan and further reduce the monthly payments.  

Nate, the public school math teacher

Let’s take a look at Nate, age 55, as an example to see how a parent can manage Parent PLUS loans and still retire the way he or she wants. 

Nate is a public school teacher who makes $60,000 a year and just got remarried to Nancy, who is also a teacher.  Nate took out $130,000 of Direct Parent PLUS loans with an average interest rate of 6% to help Jack and Jill, his two kids from a previous marriage, attend their dream colleges. Nate does not want Nancy to be responsible for these loans if anything happens to him, and he is also worried that he would not be able to retire in 10 years as he had planned!

If Nate tried to pay off his entire loan balance in 10 years under the federal system, his monthly payment would be $1,443.  Even if he refinanced privately at today’s historically low rates, his payments would be around $1,200, which Nate decides is too much for him to handle every month.  Also, since Nate’s federal loans are in his name only, they could be discharged if Nate dies or gets permanently disabled.  Therefore, it is a good idea to keep these loans in the federal system so that Nancy would not be responsible for these loans.  

In a case like this, when it is difficult for a federal borrower to afford monthly payments on a standard repayment plan, it’s a good idea to see if loan forgiveness using Income-Drive Repayment plans is an option .  In Nate’s case, his Parent PLUS loans can become eligible for the Income-Contingent Repayment (ICR) plan if he consolidates them into one or more Direct Consolidation Loans.  If Nate enrolls in ICR, he would be required to pay 20% of his discretionary income, or $709 a month.  Compared to the standard 10-year plan, Nate can cut his monthly burden in half by consolidating and enrolling in ICR!

Double Consolidation

For Nate, there is another strategy worth pursuing called a double consolidation. This strategy takes at least three consolidations over several months and works in the following way.  Let’s say that Nate has 16 federal loans (one for each semester of Jack and Jill’s respective colleges).  If Nate consolidates eight of his loans, he ends up with a Direct Consolidation Loan #1.  If he consolidates his eight remaining loans, he ends up with another Direct Consolidation Loan #2.  When he consolidates the Direct Consolidation Loans #1 and #2, he ends up with a single Direct Consolidation Loan #3.  Since Direct Consolidation Loan #3 repays Direct Consolidation loans #1 and 2, it is no longer subject to the rule restricting consolidated loans repaying Parent PLUS loans to only be eligible for ICR.  Direct Consolidation Loan #3 could be eligible for some of the other Income-Driven Repayment plans like IBR, PAYE, or REPAYE, in which Nate would pay 10 or 15% of his discretionary income. 

Reducing the monthly payments 

For example, if Nate qualifies for PAYE and Nate and Nancy file their taxes as Married Filing Separately, only Nate’s $60,000 income is used to calculate his monthly payment.  His monthly payment would be $282. If he had chosen REPAYE, he must include Nancy’s annual income of $60,000 for the monthly payment calculation after marriage regardless of how they file their taxes, so his payment would have been $782.  Double consolidation can be quite an arduous process, but Nate decides to do it to reduce his monthly payment from $1,443 to $282.  

Parent PLUS borrowers qualify for forgiveness

Since Nate is a public school teacher, he would qualify for Public Service Loan Forgiveness (PSLF) and he would get his remaining loans forgiven tax-free after making 120 qualifying payments.  

Since Nate is pursuing forgiveness, there is one more important thing he can do to further reduce his monthly payments.  Nate can contribute more to his employer’s retirement plan.  If Nate contributed 10% of his income, or $500 a month, into his 403(b) plan, the amount of taxable annual income used to calculate his monthly payment is reduced, which reduces his monthly payments to $232.  

Summary of Nate’s options:  

  1. With the standard 10-year repayment plan, Nate would have to pay $1,443 every month for 10 years for a total of $173,191.  
  2. With a consolidation, enrolling in ICR, filing taxes Married Filing Separately, and PSLF, he would start with $709 monthly payments and pay a total of around $99,000 in 10 years.*
  3. With double consolidation, enrolling in PAYE, filing taxes Married Filing Separately, and PSLF, his monthly payment starts at $282 and his total for 10 years would be around $40,000.
  4. For maximum savings: with double consolidation, enrolling in PAYE, filing taxes Married Filing Separately, PSLF, and making a $10% contribution to his employer retirement account for 10 years, Nate’s monthly payment starts at $232 and his total payment would be just over $33,000.  He would have contributed over $60,000 to his 403(b) account in 10 years, which could have grown to $86,000 with a 7% annual return.  Comparing this option with the first option, Nate pays $140,000 less in total, plus he could potentially grow his retirement savings by $86,000.

*The projections in Options 2 through 4 assume that, among other factors such as Nate’s PSLF-qualifying employment status and family size staying the same, Nate’s income grows 3% annually which increases his monthly payment amount each year.  Individual circumstances can significantly change results.

As you can see, there are options and strategies available for parent borrowers of federal student loans .  Some of the basic concepts applied in these strategies may work for student loans held by the students themselves as well.  An important thing to remember if you are an older borrower of federal student loans is that paying back the entire loan balance might not be the only option you have.  In particular, if you qualify for an Income-Driven Repayment plan and are close to retirement, you can kill two birds with one stone by contributing as much as you can to your retirement account.  Also, since federal student loans are dischargeable at death, it can be a strategic move to minimize your payments as much as possible and get them discharged at your death .

Also, direct loan consolidation can be beneficial as it was in this example, but if you had made progress toward loan forgiveness with your loans prior to the consolidation, you lose all of your progress!  As always, every situation is unique, so if you are not sure about what to do with your student loans, contact us for a student loan consultation!

*A version of this article was also published in Kiplinger.  Read it here.

Mar 23

Student Loan Interest Deduction: How can I claim it?

By Saki Kurose | Financial Planning , Student Loan Planning , Tax Planning

It’s time to do your 2020 taxes!  If you have student loans and paid interest for those loans, you might be eligible for a deduction called the student loan interest deduction. For 2020, the IRS is allowing eligible taxpayers to deduct up to $2,500 of interest paid on a qualifying student loan per return.

Who can claim the student loan interest deduction?

You can claim the deduction if:

  • You were legally obligated and paid interest on a qualified student loan (for example, in other words, if your child is the one who is legally obligated to pay back his/her student loans and you had helped him/her with the payment which included interest, you cannot claim this deduction) 
  • You did not file Married Filing Separately (in other words, you filed as Single, Head of Household, or Qualifying Widow(er))
  • Your Modified Adjusted Gross Income is less than the maximum amount set by the IRS 
  • You (and your spouse, if married) are not a dependent on someone else’s return 

What is a qualified student loan?

A qualified student loan is:

  • A loan you took out for the sole purpose of paying qualified education expenses for you, your spouse, or your dependent
  • An education expense that you paid or incurred within a reasonable period of time before or after you took out the loan (the expenses need to relate to a specific academic period and a “reasonable period of time” is defined as 90 days before and 90 days after the academic period)
  • Used for education provided during an academic period of an eligible student

What are qualified education expenses?

Qualified education expenses are:

  • Tuition and fees
  • Room and board
  • Books supplies and equipment
  • Other expenses like transportation

What is the MAGI limit for claiming the student loan interest deduction?

For 2020, if you file your taxes as Single, Head of Household, or Qualifying Widow(er), you can deduct the full amount of the interest you paid (up to $2,500) if your Modified Adjusted Gross Income (MAGI) is not more than $70,000. If your MAGI is $85,000 or more, you cannot deduct any of the interest, and for taxpayers with MAGI between $70,000 and $85,000, you can claim a partial deduction.

If you file your 2020 taxes as Married Filing Jointly, the MAGI limits are simply doubled.  You get a full deduction if your MAGI is not more than $140,000   and your deduction is completely phased out if your MAGi is $170,000 or more. 

What is my Modified Adjusted Gross Income (MAGI)?

Don’t look for your Modified Adjusted Gross Income on your tax return…because you won’t find it!  Instead, you have to look for your Adjusted Gross Income (AGI) and do a little math. You can find your AGI on line 11 of Form 1040 or 1040-SR.  Then you have to add back certain deductions found on your Schedule 1, including any IRA contribution deductions, taxable Social Security payments, excluded foreign income, interest from EE savings bonds used to pay for higher education expenses, losses from a partnership, passive income or loss, rental losses, and exclusion for adoption expenses. Some of these deductions can be uncommon, so your MAGI could be the same or pretty close to your AGI.

What do I have to do to claim the student loan interest deduction?

If you go to this IRS page, you can use their interactive tax assistant to figure out if you can deduct the interest you paid on a student loan.

When you get ready to file your taxes, look for Form 1098-E. If you paid $600 or more of interest on a qualified student loan, you should receive a Form 1098-E.  And when you file, since the student loan interest deduction is treated as an adjustment to your income, you don’t have to claim it as an itemized deduction on Scheduled A to claim it.

If you have federal student loans, you may not have paid a lot of interest in 2020 since federal student loan payments were suspended and the interest rate was set to 0% in March 2020.  However, if you did pay interest on any federal or private loans, make sure to look into whether or not you can claim this deduction!

For more information about the student loan interest deduction and other tax benefits related to education, read IRS Publication 970.  And if you need help figuring out what to do with your student loans, schedule a free 15-minute call with us to learn how we might be able to create a custom plan for you!

Feb 24

The Best Way to Pay Off Federal Student Loans

By Saki Kurose | Financial Planning , Student Loan Planning

The Best Way to Pay Off Federal Student Loans

best way to pay off federal student loans

In my previous article about private student loans, I mentioned that students should consider taking out federal student loans before taking out any private loans.  

Federal student loans have protections and benefits that private student loans most likely won’t have Federal loans can be discharged if the borrower dies or becomes totally and permanently disabled. Also, borrowers may have access to Income-Driven Repayment (IDR) plans and loan forgiveness programs.  

Income-Driven Repayment Plans

Sarah was an example from my previous article.  She is a physician making $250,000 a year and has a federal loan balance of $250,000 with a 6% interest rate.  Sarah learned that she could save a lot of money by privately refinancing her federal loans.  But are there any benefits for Sarah to keep her loans in the federal system?   

What if she is thinking about starting a family and possibly working part-time but does not know when that might happen?  She wants to pay off her debt as fast as she can but does not like the idea of having required payments of $2,776 a month on the federal 10-year Standard repayment plan or $2,413 a month after private refinancing when her income temporarily decreases for working part-time.  

By keeping her loans under the federal system, Sarah has some flexibility over the amount she must pay every month.  First, she can pay more than her minimum monthly payment in any repayment plan if she wants to pay her loans off faster.  She may also have the option to enroll in one of the Income-Driven Repayment plans and make much lower payments when and if her income decreases.

How are monthly payments calculated for the IDR plans?

Under the Income-Driven Repayment (IDR) plans, the borrower’s required minimum monthly payment is calculated based on a portion of the borrower’s income.  The borrower may not be required to pay back the full amount of his/her loans. That is unlike the federal Standard repayment plan or private loans, which require the borrower to pay the principal and the interest of the loan in full over a specified term.  For example, if Sarah got married, had a child, and her income temporarily decreased to $150,000, she may qualify for one of the IDR plans, such as the Pay-As-You-Earn (PAYE) repayment plan. Then her monthly minimum payment could be reduced to $978.

IDR and Public Service Loan Forgiveness 

To see how IDR plans and forgiveness programs work together, let’s look at another example.  Jimmy is a recent medical school graduate making $60,000 a year in a residency program with $250,000 of federal student loans.  He feels that it would be difficult to pay $2,776 every month in the 10-year Standard plan or $2,413 a month after refinancing.  He is wondering if he should apply for forbearance to suspend payments until he can afford the high payments as an attending physician, just as one of his classmates from medical school, Tom, has decided to do after graduation. 

Instead of applying for forbearance, Jimmy should consider enrolling in an IDR plan (and so should Tom). For example, in the Revised-Pay-As-You-Earn (REPAYE) repayment plan, he would be required to make monthly payments based on 10% of his income for a maximum of 25 years, and the remaining balance would be forgiven and taxed as income. If Jimmy’s loans are eligible for REPAYE, his monthly payment would start at $337, which would free up $2,439 a month compared to the Standard plan!  But why should Jimmy choose to make payments when he has the option to suspend payments using Medical Residency Forbearance?

It becomes apparent when you consider how forgiveness programs work.  To see how much money they could potentially save with one of the forgiveness programs, let’s say that both Jimmy and Tom will be working for a nonprofit or a government employer while they repay their loans, making them candidates for Public Service Loan Forgiveness (PSLF).

Under the PSLF program, Jimmy would only make 120 payments in an IDR plan (REPAYE in his case) based on his income and get the remaining balance forgiven tax-free, which means that he should try to repay as little as possible.  Assuming that he gets his monthly payments calculated based on his resident salary of $60,000 for five years before he starts making $250,000, he can be done with his loan payments after ten years of payments totaling about $141,00!  Compared to the standard 10-year repayment plan in which he pays a total of $333,061, including principal and interest, he would save over $190,000 by pursuing PSLF.

medical resident's repayment options

Low IDR payments may be better than no payment

Because Jimmy started his PSLF-qualifying payments based on his lower salary as a resident, he gets his loans forgiven earlier and pays less in total compared to Tom, who chose forbearance and waited to enroll in an IDR plan and pursue PSLF until after residency.  Assuming that Tom had the same loans and circumstances as Jimmy but made all of his PSLF-qualifying payments based on a $250,000 salary, Tom would pay a total of around $263,000, which is over $121,000 more than what Jimmy paid in total.

IDR versus forbearance for PSLF

As you can see, it is important to explore your options if you have student loans (especially federal student loans) and have a strategy that aligns with your life and career plans .  It can save you tens or hundreds of thousands of dollars.  Perhaps more importantly, knowing that you have a plan and are in control of your debt can help you prepare for life events and give you peace of mind.  However, it is a complicated process full of traps. If you are not sure what to do with your student loans, schedule a free 15-minute student consultation with me here!

*A version of this article has also been published on Kiplinger.  Read it here.

 

Dec 17

Joe Biden’s Student Loan Proposals

By Saki Kurose | Financial Planning , Student Loan Planning

Joe Biden’s Student Loan Plan: what he has proposed so far

Biden's student loan plan

When the CARES Act was passed in March, payments were suspended and the interest rate was temporarily set to 0% for federal student loans.  It was just announced that the student loan relief has been extended and is now set to expire on Jan. 31, 2021.  Will the president-elect, Joe Biden, extend the temporary relief?  No one knows.

While there is uncertainty about what will happen between now and Jan. 20, 2021, we have an idea of the long-term changes that might be coming to student loans when Biden takes office.

These proposals will have to be approved by Congress to become law, but here is a summary of what Biden has proposed so far with regards to student loans.

Cancellation of up to $10,000 per borrower

On March 22, 2020, Biden tweeted that he would cancel up to $10,000 for each borrower of federal student loans.  This cancellation was originally proposed by the Democrats to be included in the CARES Act.  It did not make it into the act, but it is possible that the Biden administration will include the $10,000 cancellation as part of a future stimulus package

Monthly payment capped at 5% of your income

The Biden Plan for Education Beyond High School includes changes to the current repayment and forgiveness programs for federal loans. Currently, borrowers in Income-Driven Repayment (IDR) plans are required to pay 10%-20% of their income over the federal poverty line toward their student loans.  The Biden Plan would limit that to 5% of income over $25,000.  Also, there would be no monthly payments required and no interest accrual for individuals making less than $25,000 a year.

Automatic enrollment in IDR and student loan forgiveness

New and existing federal student loans will be automatically enrolled in the IDR plan.  Borrowers have the choice to opt-out.  This is a major change to the current complex system.  Under the current federal system, borrowers pick and enroll in one of many available plans, which can be confusing. According to the proposed plan, the remaining balance of the loan will also be forgiven automatically after 20 years of payments are made.  There would be no income tax on the forgiven amount in this new long-term forgiveness program.  

Public Service Loan Forgiveness

Biden’s proposal suggests putting a cap on the amount of forgiveness a borrower can get in the Public Service Loan Forgiveness (PSLF) program.  Again, the enrollment in the PSLF is automatic for “individuals working in schools, government, and other non-profit settings”.  However, the amount of PSLF forgiveness is $10,000 of undergraduate or graduate debt for every year of qualifying service, for up to five years, which means that the maximum amount of forgiveness would be $50,000, in contrast to the unlimited amount under the current rules.  Although this may be bad news for borrowers who were hoping to get more than $50,000 forgiven tax-free, the proposed plan allows up to five years of prior national or community service to count towards PSLF.

Private Student Loan Discharge

It has generally been very difficult to get student loans discharged in bankruptcy.

Biden has promised to enact legislation from the Obama-Biden administration to permit the discharge of private student loans in bankruptcy. 

Tuition-free colleges and universities

The Biden Plan also includes ideas for reducing the need for some students to take out student loans in the first place.  The plan proposes making public colleges and universities tuition-free for all families with incomes below $125,000.  These tuition-free colleges and universities would include community colleges and state colleges and no private colleges, except for private Historically Black Colleges and Universities (HBCU) or Minority-Serving Institutions (MSI). Only tuition and related expenses would be free.  Students and their families would still pay for other expenses, such as room and board.  

Again, these plans will not become law unless approved by Congress. But it’s good to keep track of the changes in the law that may affect your student loans and repayment strategy.  Contact us if you need help coming up with a strategy!

A version of this article was also published on Kiplinger.  Read it here!

Nov 17

Private Student Loans: Should I Refinance a Federal Student Loan?

By Saki Kurose | Student Loan Planning

Private Student Loans: Should I Refinance a Federal Student Loan?

Private student loans should I refinance a federal student loan

As college costs continue to rise, the need for students and their parents to borrow money to get a college education has also increased. Americans now owe about $1.6 trillion in student debt, according to the Federal Reserve.

In general, there are two types of student loans: federal and private.  Federal student loans are issued by the government, whereas private student loans may come from different nonfederal lenders such as banks, schools, or credit unions.  

Are your student loans federal or private?  

Over the course of your studies, you may have taken out many loans.  Since your repayment strategy may depend on the type of loans you have, it is important to take an inventory of all your loans.  If you have federal loans, you can create an account on studentaid.gov and log in to see your federal loans.  To identify your private loans, you can get a free annual credit report from Equifax, Transunion, or Experian.  Since both federal and private education loans appear on your credit report, any education loans you see on the credit report that are not listed on studentaid.gov are private student loans. 

What are some examples of the terms you may see in private student loans?

The terms of private student loans are set by the lender and, therefore, may vary greatly.  The interest rate can be fixed or variable.  Also, although most lenders realize that students do not have the means to make payments, some may require repayment anyway while you are still in school.  Generally, private loans are more expensive than federal loans and may require the borrower to have a good credit record or a cosigner.  Having a cosigner may help reduce your interest rate, but you should watch out for the risks involved. For example, the promissory note may contain a provision that requires you to pay the entire balance in case of the cosigner’s death. 

Private loans are like any other type of traditional loans, such as a car loan or a mortgage. You need to be able to afford the monthly payments.  If you recently graduated from school, you may not have the financial means to make the payments.  Federal loans, on the other hand, may come with options for postponing or lowering your monthly payments. 

Therefore, if you are thinking about taking out student loans, it is generally better to apply for and exhaust all the federal student loan options before taking out private loans

When could it be better to have a private student loan?  

If you think you will have a stable job and are confident about your ability to make the required monthly payments, having a private loan with a lower interest rate could be beneficial.  If you originally took out federal loans, you can refinance the loans with a private lender and, if you can refinance at a lower interest rate, you may save a lot of money.  However, it is important to know that you cannot refinance your private loans into federal loans, which means that once you refinance your federal loans, you will permanently lose the benefits and options under the federal system that I will discuss in my next article.

Refinancing case study: Sarah, a physician

Let’s look at Sarah as an example. She is a physician making $250,000 a year and has a federal student loan balance of $250,000 with a 6% average interest rate*. Sarah has an excellent credit history and could take advantage of the historically low interest rates right now. She finds a private lender to refinance at 2.99%.  After refinancing, she would pay $2,413 a month for 10 years compared to $2,776 for the federal Standard 10-year repayment plan and save about $43,000 in total over the 10 years.  (*Note that the interest rate for some federal loans is 0% until December 31, 2020, so Sarah may want to take advantage of that and wait to refinance.)

Sarah likes the idea of saving $43,000. She feels comfortable about her ability to make the monthly payments of $2,413. That makes her a good candidate for private refinancing.  

However, is it possible that someone like Sarah could benefit from keeping her loans in the federal system?  In my next article, I will explain when and how Sarah and a medical resident, Jimmy, could benefit from keeping their federal loans. Spoiler: There are special protections and programs for federal student loan borrowers !

[A version of this article was also published on Kiplinger: With Private Loan Interest Rates So Low, Should You Refinance a Federal Student Loan?]