Millions of federal student loan borrowers are on income-driven repayment plans such as IBR (Income-Based Repayment) and REPAYE (Revised Pay As You Earn). The big advantage of these federal plans is that borrowers make payments based upon what they can afford rather than what they owe on the loans.
To be more specific, the Department of Education calculates a borrower’s minimum monthly payment based upon their discretionary income. As salary increases, monthly payments will also increase. However, the logistics of that increase can be somewhat confusing.
Today we will look at the consequences of a one-time bonus or overtime on monthly payments. We will also discuss how raises get factored into student loan payments.
Will my overtime hours or bonus from work mean a larger student loan bill?
For most borrowers, a temporary increase in income will eventually show up int their monthly student loan payments. However, this impact is not felt right away. Additionally, there are circumstances where the extra income will not affect monthly payments at all.
The Typical Impact – When the borrower receives the extra income from the bonus or overtime, there is no immediate change to the student loan payment. Eventually, that extra income is reported to the IRS on a tax return. At a later date, that tax return is used to calculate monthly payments when the borrower certifies their income. To see how a slight increase in income can affect monthly payments, the Department of Education’s Loan Repayment Estimator is an excellent tool.
Can I make sure my bonus or overtime income doesn’t change my student loan payments?
Unfortunately, there is no provision that excludes overtime income or bonus income from being included as income for income-driven repayment plans.
However, there are a couple of ways in which the additional income will not impact monthly payments.
Method #1 to Avoid an Increase – Certify Income via Paycheck: There are two primary ways of certifying income for purposes of an income-driven repayment plan. The most common method is to use the most recent tax return. The Department of Education makes it very easy to certify in this manner. Borrowers that have had a “significant” change in income since their most recent tax return are allowed to submit to recent pay stubs. The Department of Education treats these checks as being representative of a borrower’s earnings for the entire year. Thus, if the recent checks show overtime or a bonus, monthly payments will be calculated assuming there is extra income on each check. If the two checks submitted don’t have overtime pay or a bonus, monthly payments will be calculated based upon regular earnings.
Method #2 to Avoid an Increase – Put the money in an IRA: Perhaps the best way to make sure that a bonus doesn’t increase student loan payments is to put the money in a tax-advantaged retirement account, such as an IRA. A $500 bonus and a $500 IRA contribution will effectively cancel each other out when it comes to payment calculations. It is one of the best ways to save for retirement while dealing with student debt.
The consequences of a raise on student loan payments
The obvious answer here is that a raise will mean higher IBR or REPAYE payments.
The student loan servicers do not require borrowers to report a raise immediately, but the income from the larger salary will be reflected on tax returns, and those tax returns will eventually serve as the starting point for recalculating monthly payments.
However, a raise represents an opportunity for borrowers to revisit their student loan strategy. Is student loan forgiveness a viable strategy? Would I be better off with aggressive repayment?
One option for those that get a raise would be to increase retirement savings. This approach works identical to putting the bonus in an IRA. However, in the case of a raise, the borrower reaches out to Human Resources to request an increased contribution to the company 401(k) plan. Extra money put towards retirement can be an excellent investment, and it is hard to miss a raise if you never see the increased paycheck. Many borrowers use this approach to essentially shelter income from student loan payment calculations.
The Department of Education is not really well equipped to handle fluctuating income. Extra earning from a bonus or overtime will usually be a factor in monthly student loan payments, but it can be avoided in some circumstances.