The Inflation Reduction Act & Student Loans
/By: Drew Hanessian
The passage of the Inflation Reduction Act has far-reaching implications, particularly for student loans.
For many, the years spent at college are full of fond memories; new friends, discovered passions, and boundless possibilities. However, those memories can come at great expense which persists for decades in the form of student loans.
There has been a growing movement to rid student loan borrowers of this burden by instituting debt forgiveness, and the recent Inflation Reduction Act takes a substantial step in that direction. Up to $20,000 of loan balance per borrower can be forgiven, and there are many other aspects of the law which deserve your attention if you still have student loans. Luckily, we have summarized the salient points in this post! However, please reach out if you have questions about your particular situation.
Federal Loan Debt Forgiveness
Final extension of payment pause
Public Student Loan Forgiveness (PSLF) waiver application deadline
New Income-Driven Repayment (IDR) plan
Federal Loan Debt Forgiveness
This is the highlight of the law for student loan borrowers. If you have Federally-held student loans and had an income up to $125,000 (single or married filing separately) or $250,000 (married filing jointly) in either 2020 or 2021, you are eligible for $10,000 of forgiveness. If you qualified for Pell grants during your time in college, you are eligible for $20,000 of forgiveness.
The exact definition of “income” in this case is to-be-determined, though adjusted gross income (AGI) is commonly used in other aspects of student loan administration. We also don’t know exactly when the application process will be made available, but we do know that the Department of Education (DOE) is working on it now, check here for updates.
One thing to note is that the law uses a “cliff” threshold instead of a gradual one. If you earned $1 more than the limit, you would be completely ineligible for forgiveness.
Federal Family Education Loans (FFELs) are Federally backed loans funded by private companies. The program ended in 2010, and in the past, they were not eligible for forgiveness, however, there is a push to change that. It will depend on the specific rules the DOE establishes whether or not FFELs are eligible - stay tuned.
Keep in mind that the forgiveness is per borrower, not per child. That means that if parents took out ParentPlus loans for their children, they are potentially eligible for $10,000 of forgiveness in addition to the child’s eligibility. Even graduate school loans are eligible for forgiveness, as well as loans for current students (they would have to use their parents’ incomes to qualify if they’re claimed on their parents’ return as a dependent).
Do I have to pay taxes on the amount forgiven?
Maybe. But at least not at the Federal level. Due to a bill passed during the pandemic, discharged student debt is tax-free from the IRS’s point of view. However, some states treat it differently and they count forgiven student loan debt as income. Fortunately for Californians, the Golden State follows the Federal lead and will not levy taxes on the forgiven student loans.
Final extension of payment pause
During the pandemic, the government temporarily suspended payment requirements and interest accrual on Federal student loans. Since 2020, that suspension has been extended several times, but this legislation makes it likely that the final extension is at hand. If you have student loan payments that have been paused, you should expect to start making payments in January 2023. Please take some time to evaluate your spending plan and cash flow, and be sure your log-in credentials are still working - some processors have changed entirely during the pause in payments.
PSLF waiver application due October 31, 2022
Public Student Loan Forgiveness was originally intended to erase all Federal student loans after 10 years of public service. However, the program was enormously difficult to maneuver, and up until recently, only a tiny fraction of possible borrowers were able to successfully have their loans forgiven.
In October of 2021, the DOE instituted a waiver program that expanded the types of payments that borrowers could count towards PSLF. Another aspect of the program was a 1-year window for borrowers to apply all of their repayments, even if they’d previously not qualified due to minor technicalities.
Specifically, the waiver might benefit you if
Your loans were previously ineligible FFEL loans;
You were on an ineligible repayment plan (i.e., not a 10-year Standard repayment plan or a longer Income-Driven Repayment (IDR) plan; and/or
Your payment was late, short, or a lump-sum amount.
Over $10 billion has already been forgiven under this waiver program, but less than 2 months remain before the October 31, 2022 expiration date.
New Income-Driven Repayment (IDR) plan
The final change to student loans is the introduction of a new Income-Drive Repayment plan (IDR) and changes to existing IDRs.
Previously, borrowers enrolled in an IDR had to make payments equaling 10% or 15% of their monthly discretionary income. If the amount paid off in a year was less than the interest accruing on the loan, up to half of that interest balance would be forgiven. Unfortunately, that meant that as many as 75% of borrowers on IDR plans still saw their loan balance increasing year after year, even though they were making on-time payments. After 20 years of payments, the balance would eventually be forgiven, but that would often lead to a large tax bill, inflated even further by the interest accruing every year!
The new IDR will cap the required payment to 5% of discretionary income and it fully forgives any interest that accrued on the loan in excess of the payments made that year. That means that in the event of eventual forgiveness, the balance forgiven and subsequent tax owed will be significantly less. More importantly, however, might be the psychological impact of actually being able to see balances decrease as borrowers make their payments.
Conclusion
While this law is complex and every personal situation is unique, if you or someone you know has student loans, it’s worth making sure you’re taking advantage of every opportunity this new law provides to improve your cash flow, credit score, net worth, and maybe even your feelings toward money in general - especially if you are on the PSLF track.
Please reach out to your lead planner if you have any questions, or schedule an introductory meeting here!
