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.