Your discretionary income is the most important number when calculating student loan repayments on income-contingent repayment (IDR) plans.
Fortunately, discretionary income calculations are easy. Even better, the Ministry of Education has now a great tool for estimating monthly payments on different federal reimbursement plans.
This article will cover the basics of discretionary income calculations, explain why these calculations can be unfair, and I’ll share some of my favorite “hacks” for lowering your monthly payments.
Why is my Discretionary Income important for student loan repayments?
If you have federal student loans, some of the best repayment plans are income-based repayment plans such as Income-Based Repayment (IBR), Pay As You Earn (PAYE), and Revised Pay As You Earn (REPAYE). ). The reason these plans are the best is because your student loan payment is based on what you can afford rather than how much you owe. For many borrowers, this can mean a significant reduction in minimum monthly payments. In some cases, borrowers are entitled to payments of $0 per month.
Under the IBR, the Department of Education expects you to pay 15% of your Discretionary Income for your student loans. The PAYE and REPAYE plans reduce this number to 10%. Details like your marital status and when you first borrowed a student loan will have an impact. which income-based repayment plan is best.
Sherpa tip: A new repayment plan being developed may change the Discretionary Income calculations. For the moment, it is only a proposal, but if the plan takes effect, many borrowers could benefit from even lower monthly payments.
But what exactly is discretionary income for student loans?
Before you have to pay anything under IBR, PAYE or REPAYE, the government allows you to keep 100% of your salary up to a certain point. This number is set at 150% of the poverty line. According to the Department of Education, this is the part of your income that is non-discretionary. The federal poverty level changes every year and is based on your family size. For 2023, the numbers look like this:
|household size||150% of poverty level|
*Note: These numbers are for the 48 contiguous states…Alaska and Hawaii have slightly higher numbers.
When calculating student loan repayments, your discretionary income is each dollar (pre-tax) you earn above the numbers shown in the table. Suppose your dwelling size is three people and you earn $49,290 per year. In this example, your discretionary income would be $12,000 per year. We get this figure by subtracting the $37,290 for a family of three from the annual salary of $49,290.
Calculate your payments in 2023
Once you have determined your discretionary income, divide that number by 12. The new number is your monthly discretionary income. In our example, that would be $1,000. This means that if you were on IBR, your monthly payment would be $150, and if you were on PAYE or REPAYE, your monthly payment would be $100.
Note: The exact calculation will vary depending on how you verify your income with your lender. Some people use their last two payslips while others use last year’s taxes. If you are using your most recent tax form, it will use your Adjusted Gross Income or AGI.
One of the most useful tools for calculating monthly payments is the Federal Loan Simulator. This tool allows you to use your actual loan information to generate estimated monthly payments. It also helps with student loan forgiveness Planning.
Why is Discretionary Income an unfair calculation?
How much you can really afford depends on more than just the size of your family. Unfortunately, these factors are not taken into account. If you have medical bills, owe child support, or have other private student loans, your discretionary income doesn’t change.
The 48 contiguous states are all treated the same. Whether you live in rural Kansas or San Francisco, the numbers don’t change. Applying the exact same standard without considering the cost of living means that some borrowers will have discretionary income that overstates what they can reasonably afford.
Income sheltered from discretionary income calculations
However, as stated earlier, for most people, income is based on their AGI.
Borrowers can keep this fact in mind when planning your tax.
My favorite strategy is to put money into tax-efficient retirement accounts like a 401(k) or a traditional IRA. Putting money into a qualifying retirement account will result in a lower AGI.
Putting money into a traditional IRA will do the following:
- Reduction of monthly student loan payments,
- Reduce the amount spent on taxes, and;
- Build up retirement savings.
The approach is particularly effective for borrowers working on student loan forgiveness because it means more debt will be canceled in the end.
Unfortunately, not all borrowers are able to save money for retirement. The good news is that there are other ways to lower your AGI. Borrowers should seek tax breaks considered to be above the line. i will jump AGI calculation detailsand just point out that any deduction above the line will reduce the AGI.