As student loan borrowers face a new year, many are in a new environment. This change is due to a significant shift in repayment trends. Income-Driven Repayment (IDR) methods now account for approximately 62% of federal loan repayment based on dollars. This new student loan repayment trend requires better tax planning for 2024 tax filing decisions.
Due to various loan repayment extensions and programs, many borrowers face a new situation in 2024. While the IDR methods offer many advantages, they also come with additional complexities that are often not explained or understood. The annual income recertification will restart in March 2025 using 2024 tax information. Some borrowers have not done it before and have not recertified their income since 2020.
Here is a chart showing the change in repayment trends from traditional fixed to IDR methods.
There are a few reasons for this change:
- Lower monthly payments
- Qualifies for loan forgiveness programs
- Promoted by the Department of Education
What Are the Differences and Types of IDR Methods
Traditional loan repayment is based on the debt amount, loan interest rates, and repayment time frame. The IDR calculation is different. It primarily uses a borrower’s or couple’s income to determine the monthly payment and factors in the debt amount and interest rate.
Both methods calculate an amortization table, but their methods for calculating the monthly payment and reducing the outstanding balance are very different. With the IDR method, the loan balance could increase, which most borrowers are not told by the loan servicer and are surprised when their balance keeps increasing. Most perceive that the payment is similar to a fixed loan repayment, where the loan balance will not increase.
Benefits of Using IDR Methods
Congress started to implement these types of programs before 2000. The initial intent was to help borrowers stay current and reward borrowers who worked for government agencies and specific non-profit organizations. The formal Public Service Loan Forgiveness (PSLF) was established in October 2007.
To properly qualify for most loan forgiveness programs, the borrower needed to use an IDR method. Unlike a fixed payment method, an outstanding balance would be due based on how the monthly payment is calculated. Under the IDR methods, a loan balance at the end of the term could be forgiven. Depending on the forgiveness plan being pursued, the forgiven amount could be taxed or have a tax-free benefit.
Student Loan Borrowers Underestimate the Complexities of Income-Driven Repayment (IDR)
As stated above, traditional payment is much easier to understand since only three major factors are involved in the calculation. With IDR, the payment amount is based on the borrower’s actual adjusted gross income (AGI). Proper income management is where the complexity starts.
Various items, such as retirement and health savings accounts, can lower the borrower’s income, specifically the AGI. These adjustments, in turn, can reduce your IDR monthly payment. If you are a married couple and only one spouse has federal student loan debt, filing married and separate could be an advantage.
These strategies add complexities that can improve borrowers’ repayment and forgiveness outcomes. The downside is that the loan servicer cannot provide this advice since, legally, they cannot offer any tax or personal financial advice, yet your IDR loan repayment is based on your income.
Link Between IDR and Taxes
The Department of Education (DOE) has begun integrating tax information directly into various systems. It is not mandatory yet, but I believe this will occur shortly. The IDR methods will use the information reported in the tax return, so proper tax planning will be critical.
As part of the IDR process, the borrower’s income needs to be recertified each year. This was put on hold for almost five years due to various extensions. These extensions have ended, and income recertification will restart in March 2024. The restart of income recertification is why borrowers need additional tax planning for 2024.
Simple adjustments could save a borrower and family thousands of dollars a year.
Who’s 2024 Tax Filing Decisions are Critical
The general statement applies to any borrower who is using or considering an IDR student loan repayment strategy. This would include students and parents of 2024 or 2025 graduates who have federal student loans. The reason for this group is that their repayment will likely start sometime this year, and if they use the most recent tax return after the grace period, it would be 2024 tax information.
Another group that could be overlooked is those who got married after 2020. For most married couples, filing your taxes as married and joint is the most tax-effective option. If only one of the spouses has federal student loans you will need to investigate the tax filing status and married and separate. The reasoning here is that if the borrower files married and joint, it may use the income from both spouses to calculate the monthly payment and not just the borrower’s.
Another group is the 8 million borrowers who enrolled in SAVE. These borrowers are likely to face a change. Based on the current environment, these borrowers will need to change their loan repayment method in 2025 or early 2026.
New Student Loan Repayment Trend Requires Better Tax Planning Summary
The increased use of IDR methods could be a blessing and a curse. The lack of information and tax advice is understated. Borrowers need better advice and tools to help them navigate these decisions. It is not just the repayment method but also your tax filing decisions, retirement account deductions, and who should claim the dependents.
The Student Loan Payer software estimates the different scenarios a family may have and projects the outcome. These insights are not available through the loan servicers.
Another trend is the number of parents carrying student loans into retirement. The IDR options can be a great solution if proper planning is done. We can help you navigate the various strategies related to Parent PLUS loans and the strategies related to the IDR method of planning.
