Category Archives for "Student Loan Planning"

Ways to Divide Parent Loans in Divorce

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

Introduction

Divorce is stressful and complicated and hurts on so many emotional and financial levels. It becomes even more complex when you throw in the additional financial stress of student loans. It can be hard to deal with even after you have decided that a student loan is a marital or separate debt.

Student loans are a complex liability because there are so many different and complex methods for repayment. They come with many acronyms such as PAYE, REPAYE, IDR, and PSLF.

The borrower’s circumstances can also play a huge factor in deciding how to deal with student loans properly. For example, you might not have to repay your student loans in total if you get student loan forgiveness for various reasons. The most common are taxable long-term forgiveness or Public Service Loan Forgiveness.

How student loans are handled in a divorce is not altogether easy to understand. Depending on the laws of the State in which the divorce occurs, if one of the parties incurred student debt before the marriage, it could be considered separate property. It is especially common if the borrower’s partner received no economic benefit from the student loans or if the parties come from certain states that have community property laws (1).

But what happens if you have Parent PLUS loans that you took out for your children? Let’s imagine a case in which a couple has been married for years, and one spouse has taken out $250,000 of Parent PLUS loans under her name to pay for their two children’s college education.

Unfortunately, this is a common situation. Arguably, because the Parent PLUS loans were taken out during the marriage for the benefit of their children, they ought to be considered marital debt (1).

$250,000 of Parent PLUS loans

Let’s take a closer look at the case of Jack and Jill. They are both 55. Jack makes $180,000 a year working for an accounting firm, and Jill makes $45,000 working for a 501(c)(3) non-profit organization.

Jill has $250,000 of federal Parent PLUS loans that charge a 6% interest rate. As a result, Jack and Jill expect to pay $2,776 a month or $33,312 a year. Even with a joint income approaching $200,000, it is a significant financial burden that impairs their ability to plan for retirement and other long-term goals.

Refinancing the Parent PLUS loans

If Jack and Jill refinance at 3%, it will reduce the monthly payments to $2,414 a month. Although the $362 monthly savings are welcome, they are not a significant improvement in their situation.

Divorce has a way of making money scarce and future projections challenging. In many divorces, the division of assets and debts approaches 50%, meaning that the burden of paying for her half of the loans would be significantly greater on Jill, who only makes $45,000 a year. Even with an asymmetric division to reduce Jill’s share, it will likely not be easy to sustain (2).

Other Factors to Consider in Divorce

Jack and Jill have agreed to sell the family home as part of the divorce. They expected to net about $250,000 after expenses and mortgage repayment to be divided equally. Jack wants to use the proceeds from the sale to pay off the entire parent loan balance. Jack had heard horror stories about other parents not being able to retire because of parent loan payments, so he wanted to get rid of the balance and not worry about monthly payments that could continue into his retirement.

So, he and Jill decide to split the loans down the middle. It means that Jack will pay Jill $125,000 from the sale of their shared home since the Parent PLUS loans are in Jill’s name. With that, Jack’s share of the parent loan debt is addressed, and he believes that Jill should use her share of the sale to pay her half of the debt.

Summary of Jill’s Parent Loan Repayment Options

Here’s the thing. With the $125,000 that she would receive from Jack and her $125,000 share from the home sale, she could pay off the debt and move on to other issues. Jill was all in on the idea of each side paying half of the loans until she spoke to a Student Loan Strategist and decided to take a different route with the $250,000 of Parent PLUS loans still in her name.

Jill has always been passionate about providing support for vulnerable children worldwide. She works full-time at a local charity, a 501(c)(3) non-profit organization, making $45,000 a year. She loves her work and has no plans to retire for at least ten years. In this case, Jill could qualify for Public Service Loan Forgiveness (PSLF). It means that she could get her loans forgiven tax-free after she makes 120 monthly payments in an Income-Driven Repayment plan (2).

Here is a summary of Jill’s parent loan repayment options:

1. Make a lump-sum payment of $250,000 from the sale of their marital home ($125,000 from Jack + $125,000 of Jill’s share) to pay off the entire loan balance.
2. Keep the $250,000 proceeds and pay off the loans with the federal Standard 10-year repayment plan or private refinancing.
3. Enroll in an Income-Driven Repayment plan and pursue PSLF.

Let’s take a look at each option in detail.

1. Make a lump-sum payment of $250,000 from the sale of their marital home ($125,000 from Jack + $125,000 of Jill’s share) to pay off the entire loan balance.

In this case, the total cost of the parent loan is $250,000. This way, Jill can get rid of the parent loans in her name. However, Jill still needs to figure out her post-divorce life, including how to pay for her new housing and how to invest the other assets she may receive from Jack from the asset division from their divorce.

2. Keep the $250,000 proceeds and pay off the loans with the standard federal 10-year repayment plan or private refinancing

The cost of paying off $250,000 of federal loans with 6% under the default 10-year Standard repayment plan is $2,776/mon and $333,061 total over the ten years. However, if Jill could find a private refinancing deal at 3% interest for the same 10-year term, the cost is $2,414/mon and $289,682 total, which is $362/mon and $43,379 savings in total. It may make sense for Jill to do that if she needed to use the $250,000 home sale proceeds to buy a new house to live in, and she could afford the $2,000+ per month of payments for the student loans. However, this is not an attractive option for Jill since her monthly income is $3,750, and the loan payments would absorb so much of it. Even if her divorce agreement provided for alimony, it would still be difficult.

3. Enroll in an Income-Driven Repayment plan and pursue PSLF

Typically, federal Parent PLUS loans are only eligible for one of the Income-Driven Repayment plans called the Income-Contingent Repayment (ICR) plan even after being consolidated into a Direct Consolidation Loan.

Still, in some cases, they can be “double consolidated” (read more about this loophole strategy here) and qualify for cheaper Income-Driven Repayment plans. For example, let’s say that Jill double consolidated her parent loans, enrolled in Pay As You Earn (PAYE), and pursued Public Service Loan Forgiveness for ten years. Then, filing taxes as Single every one of those years, working for the 501(c)(3) employer and making the same level of annual income ($45,000 adjusted annually for inflation), she pays $205 to $283 monthly and a total of $29,059 over ten years.

The remaining loan balance (which happens to be $430,633 under this scenario) is forgiven tax-free under current tax rules. In this case, assuming that Jill makes the $205~$283 monthly payments out of her cash flow, she gets to keep all $250,000 from the home sale proceeds and pay off the parent loans for just under $30,000. She can use the $250,000 to buy a new home for herself or invest it in retirement, whatever she and her wealth strategist thought would work best (3).

The burden is still on the Borrower spouse

Did we mention that student loan repayment options can be complicated? Jill should ensure that she has her ducks perfectly aligned before engaging in the double consolidation/PSLF strategy. In the worst case, she could have missed something and may remain liable for the entire loan and the full payment or end up with a very large tax bill. Hence Jill should get an experienced student loan strategist to counsel her on her strategy.

If she felt inclined, she could discuss this PSLF option prior to the divorce with Jack and divide the benefit between them. However, Jill should remember that the burden is still on her because under this strategy, she has to stay in the PSLF program for ten years. That obligation is not quantified but should be considered in the asset division.

Summary

Sometimes we can find a silver lining in the worst situations. In their divorce, Jack and Jill could take advantage of a quirk of student loans and could save up to hundreds of thousands of dollars. As a result, Jill could have an additional $220,234 to support her lifestyle.

Student loan repayment strategies can be very different depending on the situation. For example, it would be an entirely different situation if Jill’s income was higher, her employment did not qualify her for PSLF, or she retired earlier than expected. There are still pitfalls ahead for her.

Solutions to student loan problems tend to be very unique and difficult to generalize. If you have federal student loans, the short and long-term costs can significantly differ depending on your income situation and the repayment plan you choose. However, as a federal student loan borrower, remember that you do not always have to pay back the entire loan balance.

Everyone’s situation is different, especially in divorce, especially with student loans. If you are unsure what to do, reach out for help. It might pay off!

Notes:

• Consult an attorney to figure out what applies to you
• Consult a financial professional with a specialization in student loans
• Consult a financial planner
• Note: The projection in the PSLF option assumes that, among other factors such as Jill’s PSLF-qualifying employment status and family size staying the same, Jill’s income grows 3% annually, which increases her monthly payment amount each year. Individual circumstances can significantly change results.

Public Service Loan Forgiveness: limited waiver opportunity

By Saki Kurose | Student Loan Planning

Public Service Loan Forgiveness (PSLF) is a loan forgiveness program offered by the government for borrowers who work for a U.S. federal, state, local, or tribal government or not-for-profit organization. Under PSLF, public service workers can get their federal student loan balance forgiven after making 120 qualifying payments while working for a qualifying employer.

The program has been plagued with issues. Many borrowers who should have qualified have not gotten their loans forgiven for reasons such as being on the wrong repayment plan, payments not being counted for unreasonable reasons, or borrowers provided with wrong information by their loan servicers.

Last month, the Department of Education announced a major change to the program that could fix some of these issues: it will “implement a Limited PSLF Waiver to count all prior payments made by student borrowers toward PSLF, regardless of loan program.”

Here’s a summary of what it means and what you have to do if you qualify.

What is the limited PSLF waiver?

For a limited time, between now and October 31, 2022, borrowers may be able to receive credit for past payments made on loans that would otherwise not qualify for PSLF. The employment requirements have not been changed. To qualify, borrowers must be employed full-time by the government, 501(c)(3) not-for-profit, or other not-for-profit organization that provides a qualifying service.

Who qualifies for the waiver?

• borrowers with Direct Loans
• those who have already consolidated into the Direct Loan program
• those with other types of federal student loans who submit a Direct consolidation application while the waiver is in effect
• students only (no parent borrowers)

Who benefits?

Students who made payments while working for qualifying employers but the loans were previously determined to be disqualified (ex: had FFEL loans instead of Direct Loans or was a wrong repayment plan like Extended Repayment instead of an IDR plan)

Who does NOT benefit?

Borrowers who:

• already refinanced to a private loan
• already paid loans off
• Parent PLUS loan borrowers (will not become eligible even if consolidated before October 31, 2022)

Do this before October 31, 2022

October 31, 2022 is the deadline to qualify for the limited PSLF waiver.

Make sure to:

• consolidate into the Direct Loan Program if you need to (borrowers with older FFEL loans from before 2010 should)
• submit a PSLF form

What payments will count?

-payments made after October 1, 2007 (when the PSLF program was started) and on or before October 31, 2021

What to expect

Automatic adjustments will be made:

• When/if you have consolidated your loans into the Direct Loan Program and submitted the PSLF form, you will see automatic adjustments in your account.

If you’ve already done all the above steps:

• You don’t need to do anything until you receive an update/communication from Student Aid

If you have Direct Loans but haven’t applied for PSLF:

• Submit a PSLF form to see if your current or past employers qualify for PSLF by October 31, 2022 (don’t wait- expect delays)

If you have FFEL loans or Perkins loans:

• submit a consolidation application to get the loan into Direct Loan program
• submit PSLF form by October 31, 2022

Don’t know what types of loans you have?

• log into your studentaid.gov account, My Aid and see your Loan Breakdown section
• ”FFEL” (Federal Family Education Loans) or “Perkins” must be consolidated (it becomes a Direct Consolidation loan afterwards) to qualify for this Waiver

As always, if you are not sure what to do, book a free introductory call with a student loan expert to make sure you don’t miss this opportunity!

New Graduates’ Guide to Paying Off Student Loans

By Saki Kurose | Financial Planning , Student Loan Planning

Congratulations on finishing your degree! Now it’s time to study up on the best way to pay off your student debt. You have a lot of options, so choose your strategy wisely.

If you have recently graduated from college or graduate school with student loans, you might be wondering what to do about your loans. How long will it take to pay off the debt? How much would you have to pay monthly? When do you start the repayment?

Those are just some of the questions you may have as you are getting ready to start a new chapter of your life after school. This article will guide you through some of the terms you will need to know, concepts that are unique to student loans, and actions you can take to take control of your student loans.

I’m done with school. Now what?

Before you pick a student loan repayment plan from a list of acronyms you do not really understand, assess your current financial situation and think about your career and goals . You cannot get to your destination if you do not know where you are starting.

First, you need to know what happens when you graduate, leave or drop below half-time enrollment from your college or graduate or professional school. If you have federal loans (such as Stafford loans), you may have a grace period or a deferment period, which is typically six months, before you have to start making payments. If you cannot make the payments, you may apply for forbearance. You are not required to make payments during the grace period, deferment or forbearance. However, be aware that interest may continue to accrue during the period of non-payment.

Take an inventory of your loans

Use this period of time to take an inventory of all the loans you have taken out during the course of your studies.  If you have federal loans, log into or create your studentaid.gov account. You will see all of your federal loans listed there. If you have private student loans, you can get a free credit report to see all of your loans. You can get one from any one of the three credit bureaus or a site like annualcreditreport.com.  If you only have private loans, you can skip to the section titled “Strategy #1: Paying your loans off as fast as possible to minimize interest.”

Federal student loans are unique and complicated

Federal student loans are different from other types of loans because they come with benefits such as flexible payments, forgiveness, and forbearance or deferment. This plethora of options was put in place to make repayment easier for borrowers, but too many choices can be intimidating and it is easy to get overwhelmed.

The most important thing to know is that you do not always have to pay back the full amount of the loans you took out. For federal loans, when you repay under the standard 10-year plan or the extended and graduated repayment plans, you pay back the entire loan including the principal and interest over a set period of time. However, if you enroll in one of the Income-Driven Repayment (IDR) plans, you pay a percentage of your income for a set period of time and then the remaining balance is forgiven. This type of loan forgiveness can either be tax-free or taxable, meaning that the forgiven dollar amount is either counted as part of your income or not in the year it is forgiven.

Special considerations for Income-Driven Repayment plans

Pursuing loan forgiveness in an IDR plan can be quite complex and therefore, it is important to know how the system works and have a strategy to navigate through it if you want to save money. If you are enrolled in an IDR plan, you should know that:

1. You must verify your income every year to recalculate your monthly payments.
2. If you are married and file your taxes as Married Filing Separately instead of Jointly, your monthly payment is lower in all but one IDR plan (the one exception is the Revised Pay As You Earn plan) because only your income is used to calculate the payment amount.
3. Loans paid under an IDR plan qualify for forgiveness if there is a balance remaining at the end of the term.

Loan Servicers

Also, look for communications from your loan servicer. They handle the administrative tasks relating to your student loans, such as billing, at no cost to you.  However, do not rely on the servicers to choose your repayment plan or strategy because the servicers are not trained finance professionals. There are short- and long-term implications for any student loan repayment option you pick, and they can be significant. Depending on the repayment plan you choose, you can save or lose thousands (or even hundreds of thousands) of dollars. YOU need to know what strategy is best for you!

Beware of scammers

There are a lot of third-party companies that take advantage of borrowers who are confused by the federal options. Some may offer to consolidate your federal loans for a fee, or even worse, offer discounted repayment options that do not exist. There are no fees for changing repayment plans or consolidating within the federal system, and the government will never contact you to offer a “discount” or a “deal” for your student loans . If you get such an offer, ignore them. These scammers often sound professional and knowledgeable. DO NOT, under any circumstances, give out your personal information, such as your Social Security number or your studentaid.gov login information.

Prioritize your career and goals: What’s most important to you?

When you know how much you owe and know what to expect after you graduate, you must assess where you are financially at the moment and where you think you will be and want to be in the short term and long term.  If you have a job, what is your income right now? How do you expect your income to change in the next five, 10, or 20 years?  What are your career plans and goals? And perhaps more importantly, what is most important to you? Do you want to be debt-free and financially independent as quickly as you can and want to live frugally to achieve that goal? Or do you want to get married, buy a house, and enjoy time with your family while you manage your loans long-term?

There is no right or wrong answer. When you have the big picture of your financial situation and goals, you can start strategizing.

Strategizing based on your goals

If you want to prioritize saving money, there are two main loan repayment strategies:

1. Pay your debt off as fast as possible and minimize interest.
2. Pay as little as possible and maximize forgiveness.

Strategy #1: Paying your loans off as fast as possible to minimize interest

By paying off the entire balance of your loans as fast as you can, you can save money because you are minimizing the interest accruing on the loans. You can also reduce the interest rate by refinancing your loans to get a lower interest rate as shown in my blog article: “Private Student Loans: Should I Refinance a Federal Student Loan?“

You can save a lot of money by shopping around for good rates, and it is often a good idea to refinance multiple times if you can save money. However, if you have federal loans and you are considering refinancing, it’s important to know that you will permanently remove your loans from the federal system, which means that your loans will no longer be eligible for benefits such as IDR plans and loan forgiveness.

Strategy #2: Paying as little as possible in IDR and maximizing forgiveness

A lot of us are taught to get rid of debt, so this may seem counterintuitive, but if you pursue student loan forgiveness, you can save more money by paying into your loans as little as possible. Those who pursue this strategy should explore all of the planning strategies used to lower their monthly IDR plan payments and make sure they are doing everything correctly to be on track for forgiveness. (To see an example of how IDR plans and forgiveness programs work together, you can take a look at the case studies in this blog article: “The Best Way to Pay Off $250,000 in Student Loans.”)

An alternative strategy: Keeping your loans in the federal system

There is another strategy that is less commonly pursued because it might not necessarily save you money. Let’s call this the “federal insurance” strategy. With the federal insurance strategy, you keep your loans in the federal system even if it costs you more, but you would be protected from any unexpected events, such as losing your income. Think about how federal borrowers who lost their jobs during the pandemic benefitted from the 0% interest and the payment freeze that was put in place in March 2020. This is a good strategy if you are expecting or experiencing big life changes, such as a growing family or job changes, and your cash flow is not stable.

Conclusion

Student loans can be intimidating. You may hear terms such as refinancing, consolidation, income-driven repayment plans and their confusing acronyms and wonder if you should also do whatever it was that your friend did. But questions like “Should I refinance?” or “Should I consolidate?” are not the questions you should be asking first. They are simply tools for managing your finances to live the kind of life you want. If you are not sure about what to do with your student loans, schedule a free 15-minute call with us to find out how you can benefit from working with a Certified Student Loan Professional to get a customized student loan repayment plan!

 

*A version of this article has also been published on kiplinger.com. Read the article here.

Ways to pay off Parent PLUS loans

By Saki Kurose | Financial Planning , Student Loan Planning

Introduction

Young adults are not the only ones saddled with the obligation to pay back massive amounts of student loan debt.  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 student loan 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 student loan 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.

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!

The Best Way to Pay Off Federal Student Loans

By Saki Kurose | Financial Planning , Student Loan Planning

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.

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.

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.

 

Joe Biden’s Student Loan Proposals

By Saki Kurose | Financial Planning , Student Loan Planning

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!

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

By Saki Kurose | Student Loan Planning

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?]