Enjoy this week's edition of the Planner's Beta
Beta (n) - climber's jargon that designates information about a climb This digest's purpose is to share observations, ideas, and treasures found this week which you may also find insightful. Sharing does not mean it's an endorsement. I am endorsing the pursuit of knowledge and exploration.
Understanding the Basics of Income Drive Repayment Plans
Are you struggling to figure out what your next move is with your student loans? With administrative forbearance coming to a close later this year, borrowers will have more questions about what they need to do with their student loans. This segment is part three of a multi-part series where I'm helping folks understand what student loans are, how they can pay back their loans, and the strategies that may be available to them. Parts one and two focused on helping people understand the federal loan program and private loans.
But in today's video, I'm going to focus primarily on helping people understand the basics of income-driven repayment (IDR) plans.
Now, as a quick recap, there are two primary regimes for paying back federal loans. First, there are balance-based repayment plans. These balance-based repayment plans include level payment plan options such as ten or 20-year loan terms. There are also graduated payment plan options where the monthly payment starts low and increases with time.
The other bucket that I'm focusing on today is the income-driven repayment (IDR) plan. For IDRs, the income of the borrower determines the monthly payment. And IDR plans are usually best for folks who cannot afford payments under a standard 10-year repayment plan or if they're pursuing public service loan forgiveness (PSLF).
Why IDRs? - An Example
Let's look at an example to illustrate why somebody would want to consider an income-driven repayment plan. In this example, we're reviewing Sam's situation. She is a recent graduate who has an advanced degree. Because she took on debt to finance her undergrad and graduate school education, she has over $230,000 in student loan debt. If she were to repay her loans using the standard 10-year repayment plan, her monthly payment on the loans would be almost $2,700 per month. That is more than the cost of many mortgages.
Even if her income was a hundred thousand dollars a year fresh out of school, she might find herself in a difficult situation to manage her monthly budget. To help Sam, we created a monthly cash flow statement to help her understand how much money is coming in and where it is going out. After we count for her income taxes, a modest 401k contribution (to get the bare minimum employer match), she'd have less than $3,000 of living expenses left per month. That's assuming she has no other obligations or goals. And $3,000 per month may sound like a lot to some people. But if Sam is living in a high-cost city, such as Portland, Seattle, Los Angeles, San Francisco, or New York, $3,000 isn't going to go very far. Furthermore, her situation is complicated if she has other goals or obligations to pay down.
And so, looking at an income-driven repayment plan is a strategy for people like Sam. In financial planning, evaluating alternative strategies is necessary. And evaluating IDRs is one step in finding the best decision for people who have significant debt. Considering IDRs doesn't mean that people should implement them for their situation. There are pros and cons of using an IDR plan to manage student debt. Generally speaking, the standard 10-year plan will be the cheapest and the quickest way to get out of debt. And if the borrower can accelerate the standard 10-year repayment plan, they will get out of debt faster and at a lower total cost.
But for some folks, if they have a significant amount of debt as a percentage of their income, going for an IDR may make sense. And when Sam worked with her financial planner to evaluate her situation, they found an IDR may be a reasonable alternative. She found implementing PAYE or REPAYE (two types of IDRs) would more than cut in half her monthly student loan bills from the analysis provided by her financial planner. Again, evaluating the alternatives was only the start of the conversation. But we could see through this example that IDR plans help those who have significant income and have a considerable amount of student debt. IDR plans can help those who are in a pinch to meet other obligations and goals.
Types of IDRs
There are four primary kinds of income-driven repayment plans. There's income-based repayment(IBR), pay as you earn (PAYE), revised pay as you earn (REPAYE), and income-contingent repayment (ICR). I see many folks get confused because they begin to use IDR, IBR, and ICR interchangeably. Each of those terms has a unique definition. It's important to remember that IDR does not identify a specific plan. Now let's start to compare the different IDR plans.
There are four IDR plans. But of course, things are a little confusing with student loans, especially with IDR plans. There are two forms of income-based repayment (IBR). There is Old IBR and New IBR. Old IBR is for those who have loans originated before July 1st of 2014. New IBR is a form of income-driven repayment plan for folks who have loans originated after July 1st of 2014.
Certain loans will only be eligible for specific income-driven repayment plans. All kinds of Direct Loans are eligible for ICR, IBR PAYE, or REPAYE (except Direct Loans that repay Parent Plus Loans). However, if you have FFELs, you may only pursue Old IBR. But you can, through careful consideration, consolidate those FFELs into a Direct Consolidated Loan. But that requires some careful consideration beyond the scope of this segment (as any Parent Plus loans can throw a wrench into a repayment scheme).
To qualify for specific income-driven repayment plans, you may have to meet a financial hardship test. You do have to meet a financial hardship test for IBR and PAYE. You do not need to qualify for a financial hardship test for income-contingent repayment or REPAYE. The financial hardship test is based upon a formula and a table published by the federal government.
So how's the monthly payment determined for IDRs? Each of these plans refers back to discretionary income. Discretionary income is defined by your income minus 150% of the poverty level for your household size and your residency. So, discretionary income is not the same for everybody, and it's not the same if you have a certain income, household size, or live in another state. Borrowers need to understand their payment is based upon their discretionary income.
Monthly Payments for IDR's
Let's get into the details of the plan's monthly payments. The maximum monthly payment for ICR will either be the max of the standard 12-year repayment plan's monthly rate or 20% of your discretionary income. With Old IBR, the monthly payment will either be the maximum of the standard 10-year plan or 15% of your discretionary income. And you can see why folks with FFELs would likely want to consider consolidating into a direct loan. Consolidation of FFEL to a Direct Consolidated loan may result in a more generous repayment plan. With New IBR, the max payment per month is either the standard 10-year plan or 10% of your discretionary income. With PAYE, the monthly payment is the max of either the standard 10-year repayment plan or 10% of your discretionary income. And with REPAYE, the monthly payment is just a flat 10% of your discretionary income. With REPAYE, if your income increases with time, it doesn't get capped at the standard 10-year repayment.
Taxable Forgiveness
When we're talking about the repayment period, this is when we start to talk about taxable student loan forgiveness. If you recently graduated and you are seriously considering going on an IDR plan, there is a max number of years that you will be on that plan. Based on the laws right now, once you've made 25 or 20 years of qualifying payments under an IDR plan, then the loan could be forgiven. The forgiven amount of the loan could result in taxable income, which is a planning opportunity because you've got to set aside enough money to pay for what could be a substantial future tax liability. The repayment period is the max number of years that you would be paying on that income-driven repayment plan before reaching forgiveness.
With Old IBR and ICR, the repayment period is twenty-five years, regardless of whether your loans are from graduate or undergraduate education. With New IBR and PAYE, the repayment period is 20 years. And for REPAYE, it's a little bit more complex. REPAYE has a 20 year repayment period for undergrad loans and a 25 year repayment period for grad loans.
I should put a quick note in here with the recent passing of the American Rescue Plan. There will be a short window between now and 2025, where forgiven federal loans will no longer require the borrower to pay taxes on their forgiven amount. That is something for borrowers to keep their ears to the ground on, especially if they're pursuing forgiveness via an IDR plan (PSLF is non-taxable).
In the following video, I will continue to drill down into IDR plans because there are more items to consider when evaluating an IDR. Still, today I just wanted to provide you a basic overview. And so be on the lookout for the following video. You're free to download these resources. Included in these resources are issues to consider when you're thinking about paying off your student loans. Also included is a decision tree that will help you understand if you're eligible for an income-driven repayment plan.
At Pursuit Planning and Investments, I advise Generation Y and X on managing their finances to help them plan their pursuit. As a financial planner, I've helped households evaluate their student loans and integrate their student loan repayment plan into their comprehensive financial plan. If you have questions about your unique situation, feel free to reach out to me at either nate.baim@planyourpursuit.com, or you can call or text me at 971-803-5948.
This Month's Financial Planning Item - Reviewing How to Maximize Your Savings
The K Shape Recovery led some household's savings rates to skyrocket. The personal savings rate is the highest it has been since the 1970s. Now, families may be struggling to optimize their savings strategies because of the assets they accrued.
You may have extra cash on hand, and you want to save for the future. But you may need help identifying all of the different account types to consider for your savings. This 17 point checklist provides a structured outline to guide your thoughts regarding available and appropriate saving strategies. It covers accounts across the following categories:
Foundational Savings
Healthcare Savings
Retirement Savings
Employer-provided Benefits
Business Owner Savings
Accounts To Help Future Generations
Tax-Deferred Insurance Options
Other Account Considerations
If you need independent advice on managing income and savings, please review the services I offer and place an introductory appointment on my calendar.
If you are a current Pursuit Planning and Investments client, securely upload any documents needing review to PreciseFP. I am happy to help proofread any resumes, conduct mock interviews, or support you with any career decisions you face. We can discuss this in our next scheduled check-in meeting, or feel free to place an appointment on my calendar.
Quote of the Week
"No written law has ever been more binding than unwritten custom supported by popular opinion." - Carrie Chapman Catt
Have something on your mind? Schedule a free call with Nate.
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