investment planning

Misunderstood Student Loan Repayment Issues

Most of our clients have a professional degree gained from going to college. Unfortunately, many people, not coming from wealthier families, found themselves needing to take on student loan debt to fund their college education. It is so easy to simply sign the document saying that you will repay those loans when you’re done with college. Somewhere in all that language, you heard words like “subsidized” and “unsubsidized”, but at the time you had little to no financial literacy, as it was not part of your high school education.

When getting one’s degree many people begin to think of the life they want to live after school. This could include a spouse, children, nice apartments, house ownership, etc. After finishing years of undergrad, many people find themselves needing to pursue a graduate degree, further adding to their student loan debt.

There are murmurings of some kind of student loan forgiveness, but this is a highly debated idea. True forgiveness is the public student loan forgiveness program, which requires working for a qualified nonprofit, making 120 on-time payments, and only then is your loan forgiven. With this program it doesn’t matter if you pay the lowest or the highest, your loan will be forgiven. This creates an incentive to leverage one of the income-dependent repayment programs. Typically, those who work in a nonprofit environment make less money than those who work in for-profit firms. This likely creates a bit of a mismatch between a high student loan debt, and the return on income being less than if that individual had worked in a for-profit.

Factor in tax status

The program is effectively based on income. There are ways to decrease your income on your tax return that are associated with your loan payment. I once had someone call me who was going to marry a physician that made $300,000, and they would only make about $50,000. If they had filed jointly, their income would have jumped to $350,000. This would effectively knock them out of
any income-based repayments. By filing separately, they would now qualify for income-dependent repayment plans.

If you are knowledgeable about taxes, you will discover that filing separately would also have increased the taxes on the higher-income spouse. Given that they were not already married, this likely would not be too big of a deal. If they had been married at the time, they might be told by a tax professional that doing this would increase their taxes. While this is true, running the numbers may show that paying more in taxes now, was easily offset by a lower-income dependent repayment on the loans, thus providing more cash flow to the family, saving
more money overall.

Another, often not discussed, issue about married filing separately is that it affects one’s ability to save into an IRA (or Roth IRA). The income phase-out for tax deductibility on saving into an IRA is about $10,000 (currently in 2023). So, in this case, no IRA would’ve been available to the lower-income person. The $300,000 person was already phased out by income, which today means that you make over $200,000 per year. That said, it does not exclude one from participating in a 401(k), that has much higher savings limits or any cash balance plan for that position may have been available if they had gone through their own business. If the $50,000 spouse had access to a 401(k) or 403(b), they could save up to $22,500 (the 2023 limit) reducing their income, effectively to about $26,500.

One of our clients was married and qualified for Public Service Loan Forgiveness. We advised them to file separately and save to the 2023 401(k) limit to help reduce their student loan cost. The projected savings on this individual case were about $76,000, over the course of around six years of payments. They had already made about four years of payments by the time they met us. Our fee for this work was only $2,400. If a couple is working with us as financial life planning clients, through our Envisioneering economic life planning process, then we cut that fee in half.

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