Table of Contents

Decoding Discretionary Income: Your Guide to Lower Student Loan Payments

Calculating your discretionary income is the cornerstone of understanding your eligibility for income-driven repayment (IDR) plans for your federal student loans. Put simply, discretionary income, for student loan purposes, is the difference between your adjusted gross income (AGI) and a percentage of the poverty guideline for your family size and state of residence. This number helps determine how much you’ll pay each month under an IDR plan. It’s the magic key that unlocks affordable repayment options, so let’s demystify the calculation process.

Calculating Discretionary Income: A Step-by-Step Breakdown

Here’s a detailed breakdown of how to calculate your discretionary income for student loan repayment:

Determine Your Adjusted Gross Income (AGI): Your AGI is found on your federal income tax return. Look for it on line 11 of IRS Form 1040. It’s your gross income (total income before deductions) minus certain deductions, such as contributions to traditional IRAs, student loan interest payments (up to $2,500), and health savings account (HSA) contributions. This is not your net income or take-home pay.
Find the Relevant Poverty Guideline: The Department of Health and Human Services (HHS) publishes annual poverty guidelines. These guidelines vary based on family size and state of residence (Alaska and Hawaii have higher guidelines). You can easily find the most current guidelines on the HHS website or through the Federal Student Aid website. The poverty guideline used is typically the one in effect at the time you apply for or recertify your IDR plan.
Apply the Relevant Percentage: Different IDR plans use different percentages of the poverty guideline when calculating discretionary income. Here’s the breakdown:
- Income-Based Repayment (IBR): Uses 150% of the poverty guideline for borrowers who were considered new borrowers on or after July 1, 2014. For older IBR plans, it’s 100%.
- Pay As You Earn (PAYE): Uses 150% of the poverty guideline.
- Revised Pay As You Earn (REPAYE): Uses 150% of the poverty guideline.
- Income Contingent Repayment (ICR): Uses 100% of the poverty guideline.
Calculate the Poverty Guideline Threshold: Multiply the applicable poverty guideline amount by the percentage used by your chosen IDR plan (100% or 150%).
Calculate Discretionary Income: Subtract the poverty guideline threshold (calculated in Step 4) from your AGI (from Step 1).
- Discretionary Income = AGI – (Poverty Guideline x Percentage)

Example:

Let’s say your AGI is $50,000, you have a family size of two (yourself and one dependent), you live in a state where the poverty guideline for a family of two is $20,000, and you’re applying for PAYE (using 150% of the poverty guideline).

AGI = $50,000
Poverty Guideline = $20,000
Percentage (PAYE) = 150%
Poverty Guideline Threshold = $20,000 x 1.50 = $30,000
Discretionary Income = $50,000 – $30,000 = $20,000

Therefore, your discretionary income would be $20,000. This figure would then be used to calculate your monthly payment under the PAYE plan.

The Importance of Accurate Calculation

A correctly calculated discretionary income is crucial for several reasons:

Affordable Payments: It directly influences the size of your monthly student loan payments under IDR plans. A lower discretionary income translates to a lower monthly payment.
Eligibility: It helps determine your eligibility for specific IDR plans. Some plans have income requirements or caps based on discretionary income.
Loan Forgiveness: IDR plans offer potential loan forgiveness after a specified repayment period (usually 20 or 25 years). The accuracy of your discretionary income calculations impacts the total amount you repay before forgiveness.

FAQs: Mastering Discretionary Income for Student Loans

Here are 12 frequently asked questions to further clarify the intricacies of discretionary income and its impact on student loan repayment:

1. What happens if my income changes after I enroll in an IDR plan?

You are required to recertify your income and family size annually. If your income has increased, your monthly payments will likely increase. Conversely, if your income has decreased, your payments may decrease. It’s vital to report any significant changes in income or family size promptly, as this can affect your payment calculation.

2. How does my spouse’s income affect my discretionary income calculation?

IBR and PAYE: If you are married and file your taxes jointly, your spouse’s income will be included in your AGI, impacting your discretionary income calculation. If you file separately, only your income is considered. However, filing separately may have tax disadvantages.
REPAYE: Regardless of whether you file jointly or separately, your spouse’s income will be included in the discretionary income calculation. REPAYE treats married borrowers as a single economic unit.
ICR: Similar to IBR and PAYE, if you file jointly, both incomes are included; if you file separately, only your income is used.

3. Can I lower my AGI to reduce my discretionary income?

Yes, you can lower your AGI by maximizing eligible deductions on your tax return. Contributing to pre-tax retirement accounts (like a 401(k) or traditional IRA), deducting student loan interest, and utilizing health savings accounts (HSAs) are all ways to reduce your AGI and, consequently, your discretionary income. Consulting with a tax professional is highly recommended.

4. Are there any expenses besides the poverty guideline that are considered when calculating discretionary income?

No. The formula for calculating discretionary income for IDR plans only considers your AGI and the relevant poverty guideline based on your family size. Other expenses, such as rent, utilities, or childcare, are not factored into the calculation.

5. What if I am self-employed? How does that affect my discretionary income?

Self-employed individuals calculate their AGI in the same way as those with traditional employment – based on their tax return. However, self-employed income can be more variable, making accurate income projection for IDR recertification crucial. Be sure to account for all business expenses that can be deducted to lower your AGI.

6. What happens to my loan balance if my payments are not enough to cover the interest accruing on my loans?

This is a common concern. On many IDR plans, if your monthly payment doesn’t cover the accruing interest, the loan balance can increase over time (negative amortization). However, some IDR plans, like REPAYE and IBR, offer interest subsidies for a specified period, meaning the government pays a portion of the unpaid interest. It’s critical to understand the specific terms of your IDR plan.

7. How often do I need to recertify my income for IDR plans?

You are required to recertify your income and family size annually, even if your income has not changed. Your loan servicer will typically notify you when it’s time to recertify. Failure to recertify on time can lead to an increase in your monthly payments or even removal from the IDR plan.

8. What documentation do I need to provide when recertifying my income?

Typically, you will need to provide documentation of your income, such as your most recent federal income tax return (Form 1040). In some cases, if your income has significantly changed since your last tax return, you may need to provide alternative documentation, such as pay stubs.

9. Can I switch between different IDR plans?

Yes, you can generally switch between different IDR plans, but it’s important to understand the implications of doing so. Switching plans may affect your eligibility for loan forgiveness, the length of your repayment period, and the way your discretionary income is calculated. Use the Federal Student Aid’s Loan Simulator to compare different plans.

10. How do I know which IDR plan is the best for me?

The best IDR plan for you depends on your individual circumstances, including your income, family size, loan balance, and loan type. The Federal Student Aid Loan Simulator is an excellent tool for comparing different IDR plans and estimating your monthly payments under each plan. Consulting with a student loan advisor can also provide personalized guidance.

11. What happens to my discretionary income calculation if I have multiple student loans with different interest rates?

The interest rates on your individual loans do not directly affect your discretionary income calculation. Discretionary income is solely based on your AGI and the poverty guideline. However, the weighted average interest rate across all your loans will influence the overall cost of repayment, particularly if you’re not on track for loan forgiveness.

12. Are Parent PLUS loans eligible for IDR plans and discretionary income calculations?

Direct Parent PLUS loans are not directly eligible for most IDR plans. However, they can become eligible for the Income Contingent Repayment (ICR) plan if they are consolidated into a Direct Consolidation Loan. It’s crucial to understand that REPAYE is not an option for consolidated Parent PLUS loans unless you can convince the department that you’ve over borrowed to help your children going to school.

Final Thoughts: Empowering Your Student Loan Journey

Understanding and accurately calculating your discretionary income is paramount to effectively managing your student loans. It allows you to access affordable repayment options and potentially qualify for loan forgiveness. By carefully reviewing the steps outlined above, utilizing available resources, and seeking professional advice when needed, you can navigate the complexities of student loan repayment with confidence and build a solid financial future. Remember that the information provided is for guidance only, and consulting with a qualified financial advisor or student loan expert is always recommended for personalized advice tailored to your specific situation.