How an IDR Plan Offers Valuable Loan Forgiveness

As of writing, 8.7 million borrowers are enrolled in an income-driven repayment (IDR) plan, according to the US Department of Education. The reasons are hardly shocking.

For one, borrowers are required to be on an IDR plan for Public Service Loan Forgiveness (PSLF), though the recent PSLF waiver allows borrowers to get credit even if they weren’t on an IDR plan.

For others, IDR is a way to lower their monthly payment while as borrowers figure out their career, or if they experience a loss of income. Still, more borrowers are catching on to one of IDR’s biggest benefits, federal student loan forgiveness.

What to know about income-driven repayment

IDR is an umbrella term that encompasses several different repayment plans. Like its name implies, these plans calculate your student loan payment based on a percentage of your discretionary income, depending on which plan you choose, and your family size.  Currently, there are four plans you can choose from.

Revised Pay As You Earn (REPAYE)

On a REPAYE plan, your payment is calculated at 10% of your discretionary income. Regardless of how you and your spouse file your taxes, the plan always takes into account both of your incomes.

Any borrower with eligible loans can get on this plan.  If your payment isn’t enough to cover the accrued interest, the interest due will receive a 50% subsidy.

Pay As You Earn (PAYE)

This plan requires you to have a partial financial hardship (PFH) to qualify. It allows your monthly payment to be less than what you’d pay on a standard repayment plan.

For PAYE, you must have been a new borrower as of October 1, 2007, with at least one loan borrowed after October 1, 2011. This means if you borrowed a Direct or FFEL loan in 1990 and paid it off before October 1, 2007, you’re considered a new borrower!

On PAYE, your payment is 10% of your discretionary income. Some borrowers can lower their monthly payment amount by filing their taxes separately from their spouse. This is a good strategy for some, but always check with a tax professional to make sure this continues to make sense as your personal circumstances change.

Another benefit of PAYE is that your payments are capped at the standard 10-year plan amount so your payments can never exceed that. Once you’re on PAYE you can't be kicked off which is good news for higher earning borrowers pursuing PSLF.

Income-Based Repayment (IBR)

An IBR plan, like PAYE, requires you to have a partial financial hardship, and caps your payment at the standard 10-year plan amount. How your payment is calculated depends on when you borrowed your loans.

If you were a new borrower before July 1, 2014 then your payment is 15% of your discretionary income. After this date, it’s 10%. Borrowers who file their taxes separately, but don’t qualify for PAYE, often choose IBR instead.

Income-Contingent Repayment (ICR)

Income-Contingent Repayment was the first ever IDR plan available, as of 1995. Like REPAYE, you don’t need to have a partial financial hardship to qualify for the plan, just eligible loans.

If you have a consolidation loan that paid off a Parent PLUS Loan, then this is the only IDR plan you are eligible for, which is why the double-consolidation strategy is so powerful.

The ICR plan calculates your payment based on 20% of your discretionary income, or the amount equivalent to a “Standard-12 year”, whichever is less. The latter calculation is based on how much it would take to pay off the loan in 12 years.

For most borrowers, this isn’t an advantageous plan but for some, it’s the only one they’re eligible for.

Common features of IDR plans

All of these IDR plans offer loan forgiveness on your remaining loan balance which is one of the primary unifying factors. PAYE is the only one to offer forgiveness after 20 years (except for REPAYE but only if you have all undergraduate loans).

The other plans are all 25-year repayment paths. Keep in mind that up until the American Rescue Plan that Biden signed in 2021, the IRS taxed all sources of income which includes forgiven debt balances through IDR.

Under the American Rescue Plan, all loans that are forgiven through the end of 2025 aren’t subject to the “tax bomb.” Unfortunately, a study done by PHEAA, one of the largest federal student loan servicers, found that only 48 borrowers would see their loans forgiven in this timeframe.

The question remains as to whether tax-free loan forgiveness through IDR will be extended or somehow made permanent. There’s political will to make that happen, but to play it safe, I typically advise borrowers to save for the possible tax bill. That way, if forgiveness is treated as taxable, you already have the funds set-aside. If taxes aren’t due on the forgiven amount, then you get to keep the money for retirement or a cool trip.

If you’re on an IDR plan for PSLF purposes, then you don’t need to worry because PSLF is always tax-free. It stands to reason that if Biden does offer any widespread loan forgiveness that survives a court challenge, it would also be tax-free.

Borrowers in repayment or forbearance, but not enrolled in IDR

One of the benefits of an IDR plan is that if your income is low, your student loan payment will be as well. This is a valuable way for borrowers to keep current with their student loans while getting credit toward 20- or 25-year forgiveness.

Unfortunately, some lenders developed a habit of inappropriately steering borrowers in financial distress toward forbearance. Forbearance has its place in the federal student loan system, but many borrowers would’ve been better served if they were offered an IDR plan. Depending on your circumstances, you might possibly have a zero-dollar payment.

Another problem is that some borrowers have been paying on their loans for a long time, with no end in sight. In fact, the Student Borrower Protection Center (SBPC) estimates that 4.4 million borrowers have been in student loan repayment for 20 or more years. The SBPC, quoting the Consumer Financial Protection Bureau, estimates that administrative errors among servicers might have kept up to 60% of borrowers from staying on track with their IDR progress.

To remedy this, the Department of Education announced an IDR waiver on April 19, 2022. Although we’re still waiting on an official FAQ, there’s still quite a bit that we do know:

• Borrowers with more than 12 months of consecutive forbearance or more than 36 months of aggregate forbearance will receive credit for these months of paused payments toward PSLF and IDR forgiveness plans.
• Borrowers who made payments on any payment plan will receive a one-time adjustment, allowing those payments to count toward IDR forgiveness. If you have a commercially held FFEL loan, you must combine your loans using a Direct Consolidation Loan to be eligible.
• All deferments before 2013, except for in-school deferment, will also count toward IDR forgiveness. After 2013, only hardship deferments will qualify.

Which student loan borrowers should go for IDR forgiveness?

Everyone’s favorite answer is “it depends.” If you’re a recent graduate at the beginning of your career, take honest stock of what your career prospects and income trajectory reasonably look like. Then, compare your debt-to-income ratio.

Generally, if your student loan debt is higher than your income, the math points toward a forgiveness scenario. If you think you’ll earn more than your debt balance, aggressive payoff might be the way to go. Some high earners, however, end up with monthly payments that are large enough to pay off the student loan before forgiveness is even possible.

Related: How to know if you could benefit from a Student Loan Planner® consult

How to maximize IDR student loan forgiveness

If you’re going for forgiveness on an IDR plan or PSLF, pay as little as you possibly can while keeping your loans in good standing. Your income tax return, specifically your Adjusted Gross Income (AGI) is used to determine your discretionary income, a percentage of which is your student loan payment.

Your pre-tax deductions at work are the easiest way to lower your AGI. If you’re contributing to your 401(k), see if you can afford to contribute a little more. Consider contributing to a Health Savings Account or Flexible Spending Account if either is appropriate for you and available.

Your health insurance premium is tax-deductible. During Open Enrollment, review your options carefully and see if you can take advantage of benefits that also lower your student loan payment.

Get help with your IDR forgiveness path

At Student Loan Planner, we look at the plans you’re eligible for, estimate how many years of credit you might get through the available waivers, and look at what each option costs you over the remaining life of the loan.

If you aren’t sure if IDR forgiveness is right for you, book a consultation and let us build a customized plan for you.