Written By Travis Hornsby, CFA®, CFP®
Updated on February 6, 2021
Justin Harvey, CFP®, and Rob Bertman, CFA, CFP®, are two student loan experts on the team, and they're exploring the income-driven repayment (IDR) plans available for federal student loans.
They'll review the different repayment options and zoom in on each one. Because some professions depend on taxable student loan forgiveness, they'll cover which of the IDR plans are best for individual careers.
Most federal student loan payments are suspended through the end of 2020, so it’s likely you’re not paying anything right now.
But that will change. To start 2021 on a new payment plan, you need to know how each works before choosing the best one for your situation.
Income-Driven Repayment Caps
One significant factor that can determine which repayment plan is right for you is a cap. “This is especially for physicians who go from residency into attendinghood or for any other high-earning professions – dentists, dental specialists, perhaps attorneys or others,” said Harvey.
The two IDR plans that have caps are:
- PAYE
- IBR
On an IDR plan, your monthly payments can increase as your income goes up. But if the repayment plan has a cap, your monthly payment will never go above the Standard Repayment Plan amount.
The Standard Plan amortizes your balance over ten years. Because the payments will pay off the loan in ten years, monthly payments are typically higher than IDR plans. Here, having a cap can save you money.
“If someone’s income is going to be high enough that they’re going to reach the cap based on debt-to-income, chances are they don’t want to stay on the plan for too long,” said Bertman.
Monthly payments as a percentage of income
How you repay your student loans comes down to strategy, and there are two paths to consider. You either want to pay off the loans as fast as possible, which usually involves refinancing your student loans to get a lower interest rate and pay it down more quickly.
Or – if you owe more than your income – you want to do the opposite: keep the payments as low as you can and maximize loan forgiveness.
“In a lot of cases, what this means is that the loan balance could grow over time, but that's actually okay because, number one, student loans have simple interest, not compound interest, and number two, it's going to get forgiven,” said Bertman.
“Even though you have to pay taxes [on the forgiven amount], you don’t want to throw extra dollars today at a 40- or 50-cent problem in 20 or 25 years.”
To pay the least amount possible, you need to know how much discretionary income each repayment plan requires you to pay:
- PAYE and REPAYE payments are 10% of your discretionary income
- IBR payments are 15% of your discretionary income
The number of years to student loan forgiveness
Public Service Loan Forgiveness (PSLF) is the ten-year tax-free forgiveness. To qualify, you must have eligible loans, work for a non-profit or government employer, and meet the other requirements.
Related: Top 40 Tips to Save Thousands with Public Service Loan Forgiveness
There’s also taxable forgiveness that is a longer-term forgiveness opportunity for each IDR plan. Whether you’re on REPAYE, PAYE, or IBR, you’ll eventually reach the finish line even if your loans aren’t paid in full:
- PAYE requires 20 years (240 qualifying monthly payments)
- REPAYE requires 25 years (300 qualifying monthly payments)
- IBR requires 25 years (300 qualifying monthly payments)
If you're pursuing long-term forgiveness, your balance will increase every month. “We want to pay the least we possibly can going for forgiveness, and you're going to watch that balance go up and up and up and up,” said Harvey.
“And that’s something that you’ve got to be psychologically ready to deal with.”
It’s the path that will cost you the least. “It means it’s more money in your pocket and less money going to pay off these loans that will ultimately be forgiven,” said Harvey.
But it's distressing to open up your statement every month to see the balance increase.
The impact of spousal income on student loans
When you’re married, you can file your taxes jointly or separately. It can make a significant difference when you’re on an IDR plan.
“If you’re filing separately, some of these repayment plans will allow you to exclude your spouse’s income from the calculation of your payment,” said Bertman.
The two plans that allow you to exclude spousal income are IBR and PAYE. For instance, if two spouses file jointly, and each makes $100,000 per year, the IDR plan will base the monthly payment on $200,000. But filing separately could cut the amount in half.
It’s important to talk to a tax professional about how filing separately could impact your situation. You may pay more in taxes by filing separately, but the benefit of a lower student loan payment might outweigh the loss in taxes.
Which plan is right for you?
When deciding between IDR plans, it's confusing to know which is best for your situation. “What we’ve found is that you don’t have to decide between all three,” said Bertman. “Typically, you’re picking two of the three.”
Generally, if you’re eligible for PAYE, you don’t need to look at IBR. If you’re not eligible for PAYE, then you’d choose between IBR and REPAYE.
But several customized factors unique to your situation can apply, making one specific plan better than another. That's why we have student loan consults. For a custom plan that analyzes your unique situation, book a consult with one of our student loan experts.
Not sure what to do with your student loans?
Take our 11 question quiz to get a personalized recommendation for 2024 on whether you should pursue PSLF, Biden’s New IDR plan, or refinancing (including the one lender we think could give you the best rate).
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