The recent student loan repayment extension is now set to begin on May 1st and borrowers should begin to properly plan for this repayment restart. As more borrowers use the Income-Driven Repayment (IDR) methods, their monthly payments will be more dependent on their Adjusted Gross Income (AGI) and how they file their taxes. This year’s tax return is critical to the student loan repayment restart.
An important part of the IDR process is income recertification. Due to COVID and the multiple repayment extensions, many borrowers have not recertified their loans in 2 or 3 years. Many borrowers could see a significant monthly payment increase due to changes in income or marital status. Without proper planning during this tax year, the restart could create financial issues.
IDR Trends and Tax Filing Importance
Since the end of 2013, the number of borrowers using an IDR method is up over 68%. Approximately, 54% of student debt dollars are now repaid using one of the IDR methods. This is a significant change yet most borrowers do not understand these methods. The biggest problem for borrowers is the lack of good advice.
Trends of Student Debt Dollars Repayment Methods
The root of the problem is the perception of traditional loan repayment. IDR is driven by a borrower’s income and tax filing method not the terms of the loans like traditional loans. The loan service companies legally cannot provide personal financial advice leaving borrowers to turn to tax professionals. Unfortunately, the tax professionals don’t understand student loan repayment resulting in a lack of beneficial resources for borrowers.
With the proper tools and resources, financial professionals and tax advisors have the opportunity to fill the void for student loan repayment. With the increased cost of college and more careers requiring post-graduate degrees, more people will have student debt. Currently, it is estimated that over 70% of the newly educated workforce will have student debt. The growing trend shows more employers adding Student Loan Assistance programs to help with retention and recruitment.
Recertification Date and National Forbearance
A major factor component of the IDR process is the annual income recertification. This is a manual process that the borrowers need to do each year. The income recertification process determines a borrower’s monthly payment for the upcoming year. Due to COVID and the multiple repayment extensions, this part of the restart could be very confusing.
To get prepared, the borrower should contact their loan servicer. They should confirm their recertification date and what their monthly payment will be at the restart. With these steps, any surprises can be avoided and it will give the borrower the information they need to create a better plan for this year’s taxes.
By knowing your recertification date, the borrower can determine which AGI number will be used at the restart and how to plan the upcoming recertification. The IDR method will use the most recent tax return on file normally within 18 months.
The penalties for not recertifying are severe so do not overlook it. Your recertification date may have changed due to COVID so you need to review it and confirm the date.
Recertification and Filing A Tax Extension
The IDR recertification process is currently manual but will be moving to an automated process in the next few years. That is why having a good plan with planning your tax filing date and your recertification due date is also important.
As an example, a borrower’s recertification date is August every year. It normally takes about 4 weeks to process a tax return if filed electronically. This would make the borrower’s tax return available for recertification somewhere around June 1. That year’s AGI would be used for the borrower’s upcoming recertification.
Depending on the income change, possible marital status change, or a change in state residency, the borrower may want to consider a tax-filing extension. This would move their tax filing date back to October 17 and allow them to use a lower AGI number. As a result, a lower student loan repayment for another 12 months.
If you file your taxes with an extension, make sure you understand the rules. You still need to make a payment if you have a tax amount due. An extension will delay any refund. For some people that could be a problem since they depend on the refund for certain expenses. This is another example where a tax professional can help in the future with a better plan.
Life Changes impact IDR Payment Amounts
In the example above, we used the tax extension to the borrower’s advantage. It may also work in the reverse especially related to the non-recertification requirement during the National Forbearance. Let’s say a borrower got married in 2020. Only one of the spouses has student debt. The most recent tax return on file has the borrower filed as married and joint.
In this case, the income used would be the joint income on file. This would increase the borrower’s repayment amount significantly if they were using an IDR method since the joint income would be used. Here this borrower would want to get their tax return in on time. It would use the borrower’s lower income only for the upcoming recertification. Resulting in a lower loan repayment amount.
These items need to be reviewed with your tax advisors before making this decision. In many cases, filing married and separate will cause an increase in taxes due and couples could lose some tax deductions or credits.
IDR Repayment Transparency Problem
As I mentioned early, the biggest void in the current process is the lack of transparency in bringing the personal taxes and repayment options together. The PayForED Student Loan Repayer helps borrowers and advisors better visualize all their options.
As you can see in the example below, a simple tax filing adjustment could be worth a savings of $658 per month for this married couple. The problem is there is a tax penalty of $1,855 annually for filing married and separate. Most tax advisors will question why you would pay the extra taxes.
This is the problem. The tax advisor’s goal is to lower your taxes and often can’t see the monthly IDR repayment impact. At the same time, the student loan servicer cannot see the tax filing option or recommend it. As a result, the borrower never gets to see the best option.
The PayForED solution brings a comprehensive view to this decision. It calculates all of the options in one place and then factors in an estimated tax penalty. In the case below, the best option will be to file married and separate and use PAYE as an IDR method. This net result is a net saving of $465 per month or $5,580 per year. This includes the monthly tax penalty of $155.
IDR is needed for PSLF
One of the reasons for the increased use of the IDR methods is Public Service Loan Forgiveness (PSLF). A borrower needs to use the IDR methods to qualify for PSLF. In addition, the borrowers who are directly employed by most non-profits or government agencies can qualify. They need to make 120 on-time payments and be a full-time employee during their payment period. After that is completed then their federal loan balance will be forgiven.
The biggest advantage is this loan forgiveness is tax-free. To date, the success rate of this program has been poor but I believe one of the biggest issues is that borrowers do not understand the AGI and tax filing process to maximize this opportunity.
There is a secondary IDR loan forgiveness program. IDR users can have federal loan balance forgiveness after 20 – 25 years depending on the IDR method and federal loan type. This end of loan forgiveness is taxable. The biggest risk for the IDR borrower is negative amortization which increases the loan balance amount. This often happens with IDR payments. For the IDR borrower who is planning to use the end of loan forgiveness strategy, this amount is taxable and will be added to that year’s income. This could create a significant tax event if not properly planned for.
For PSLF borrowers this is not a problem since their forgiven amount is tax-free.
PSLF Limited Waiver uses IDR and tax return
The PSLF program has gotten some bad press over the year due to the complexity and bad advice given to borrowers. In October 2021, the president signed the PSLF Limited Waiver program. This program allows borrowers who were previously denied PSLF to now qualify.
It is estimated that over 550,000 borrowers will qualify. That is good news. The bad news is the borrower must understand the error or errors that need to be corrected. They will need to finish their payments using an IDR method. As stated above, most borrowers don’t understand the IDR process and the loan servicers can’t provide the proper advice.
Here is a link to our 10-step process that can help borrowers and advisors navigate the PSLF Limited Waiver decision. We have saved clients between $10,000 to over $100,000 under the PSLF Limited Waiver program. This includes people who I did not think would initially qualify but when you factor in the error corrections and the earned free PSLF credits it works for more people than you think.
Summary for Tax Advisors, Financial Advisors, and Borrowers
If you are a tax professional or financial advisor the opportunity for helping people with student loan repayment is great. Borrowers have not had to make payments for 25 months. There are over 24 million people in repayment today. For IDR borrowers, proper planning is needed more than ever. A simple adjustment can lower payments. It may also help them properly qualify for the PSLF.
For borrowers, finding the right advice can be difficult. The most important step is this year’s tax return. Getting the proper tax filing information during your recertification could be significant. It could reduce the pain of the restart and help you plan for a better financial future.