Your discretionary income is the most important number when calculating student loan payments on income-driven repayment (IDR) plans.
Fortunately, discretionary income calculations are easy. Better yet, the Department of Education now has a great tool for estimating monthly payments on the various federal repayment 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” to lower your monthly payments.
Why does my discretionary income matter for student loan payments?
If you have federal student loans, some of the best repayment plans are income-driven 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 that your student loan payment is based upon what you can afford rather than how much you owe. For many borrowers, this can result in a significant reduction in minimum monthly payments. In some cases, borrowers qualify for $0 per month payments.
Under IBR, the Department of Education expects you to pay 15% of your discretionary income towards your student loans. The PAYE and REPAYE plans reduce that number to 10%. Details like your marital status and when you first borrowed a student loan will impact which Income-Driven Repayment Plan is best.
Sherpa Tip: There is a new repayment plan in development that may change discretionary income calculations. At this time, it is only a proposal, but if the plan takes effect, many borrowers could qualify for 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 lets you keep 100% of your salary up to a certain point. That number is set at 150% of the poverty level. According to the Department of Education, this is the portion of your income that is non-discretionary. The federal poverty level changes each year and is based upon your family size. For 2023, the numbers look like this:
| Household Size | 150% of Poverty Level |
|---|---|
| 1 | $21,870 |
| 2 | $29,580 |
| 3 | $37,290 |
| 4 | $45,000 |
| 5 | $52,710 |
| 6 | $60,420 |
| 7 | $68,130 |
| 8 | $75,840 |
*Note: these numbers are for the 48 Contiguous States… Alaska and Hawaii have slightly higher numbers.
When calculating student loan payments, your discretionary income is every dollar (pre-tax) that you make above the numbers listed on the table. Suppose your housed size is three, and you make $49,290 per year. In this example, your discretionary income would be $12,000 per year. We get this number by subtracting the $37,290 for a family of three from the $49,290 yearly salary.
Calculating your payments in 2023
Once you determine your discretionary income, divide that number by 12. The new number is your monthly discretionary income. In our example, it would be $1,000. That 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 two most recent pay stubs while others use last year’s taxes. If you use 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 in generating the estimated monthly payments. It also helps with student loan forgiveness planning.
Why is discretionary income an unfair calculation?
How much you can truly afford to pay depends upon a whole lot more than just the size of your family. Unfortunately, these factors are not considered. If you have medical bills, owe child support, or have other private student loans, your discretionary income does not change.
The 48 contiguous states are all treated the same. Whether you live in rural Kansas or San Fransisco, the numbers do not change. Applying the exact same standard without adjusting for the cost of living means some borrowers will have a discretionary income that exaggerates how much they can reasonably afford.
Sheltering income from discretionary income calculations
However, as noted earlier, for most people, income is based upon their AGI.
Borrowers can keep this fact in mind when doing their tax planning.
My favorite strategy is to put money in tax-advantaged retirement accounts like a 401(k) or traditional IRA. Putting money in an eligible retirement account will result in a lower AGI.
Putting some money in a traditional IRA will do the following:
- Lower monthly student loan payments,
- Lower the amount spent on taxes, and;
- Build retirement savings.
The approach is especially powerful for borrowers working towards student loan forgiveness because it means more debt will be forgiven in the end.
Unfortunately, not all borrowers are in a position to set aside extra money for retirement. The good news is that there are other ways to lower your AGI. Borrowers should seek out tax breaks that are considered to be above-the-line. I’ll skip the details on AGI calculations, and just point out that any above-the-line deduction will reduce the AGI.
I work for the VA and have a base salary and added Locality pay. The Locality pay is an acknowledgment by the feds that the cost of living in the area of my employment is higher than the norm. Why is my locality pay counted when figuring my monthly discretionary income/monthly payment?
You have identified one of the many ways the discretionary income calculation isn’t really fair. Whether you live in an expensive place like New York City or in an area with a very low cost of living, the Discretionary Income calculation doesn’t change. (The formula is a bit different for Alaska and Hawaii, but the other 48 states are treated the same.)
There are a few ways to shelter income from the calculation, but it requires a bit of careful tax planning.
I have parent plus loan debt of 82K and consolidated the loans with a payment of $570 per month. When my husband and I retire we plan to live primarily on our social security. We have 401Ks as well. How do required minimal distributions factor into our AGI? I plan to attempt to get an Income Contingent payment plan after retirement.
Social security income can be tricky for income-driven repayment plan calculations. If you are living exclusively on social security income, it will usually mean $0 per month payments.
The Minimum required distributions may shift the calculations. In retirement, traditional 401(k) withdrawals are treated as income and would impact your AGI. If you are pulling out a few thousand dollars per year, the impact on monthly payments will be minimal. If you are pulling out 100k per year, it means larger payments.
While my son was in college we took out a Parent Plus loan for him. At that time, repayment would not have been an issue. However, circumstances changed and our income has declined drastically. We are now below poverty level and the loans enter repayment next month. Can we apply for any type of income-driven repayment plan and if so, is there a way to determine what my payment might be?
one question what qualifies as a household size? my grown son and his girlfriend live with me and he has a low paying job and she is unemployed both uder 25 do they make me qualify as a family of three
Family size is defined slightly differently than what it is for tax purposes.
Here is a link to the income-driven repayment plan application: https://static.studentloans.gov/images/idrPreview.pdf
Family size is defined in section 9 as follows: Family size always includes you and your children (including unborn children who will be born during the year for which you certify your family size), if the children will receive more than half their support from you. For the PAYE, IBR, and ICR Plans, family size always includes your spouse. For the REPAYE plan, family size includes your spouse unless your spouse’s income is excluded from the calculation of your payment amount. For all plans, family size also includes other people only if they live with you now, receive more than half their support from you now, and will continue to receive this support for the year that you certify your family size. Support includes money, gifts, loans, housing, food, clothes, car, medical and dental care, and payment of college costs. Your family size may be different from the number of exemptions you claim for tax purposes.
I have over $250,000! in graduate school loans. I have signed up for the PAYE repayment plan. I am not clear about the interest capitalization as I have read in some places that the maximum interest capitalization is 10% of the loan balance at the start of the repayment period. Can you please clarify the interest capitalization associated with such loan balances as my monthly payments now and in the future may be less than the monthly interest accrual.
Excellent question. Capitalized interest becomes an issue if your monthly payment is smaller than the interest that accrues each month. You can read more about this topic and how to deal with it here: https://studentloansherpa.com/federal-student-loans-capitalized-interest/
What is the benefit of using the most recent 2 pay stubs vs the AGI? If any?. Would the 10% be calculated straight from the net income? Or would it be lower?
I made 4 times more than my wife, she have $100k in student loan and I have 0. Filling taxes jointly would benefit the tax burden but hurt us because of the higher repayment every month. Can we benefit by filling jointlyh but then reporting her most current 2 pay stubs for the repayment? Thanks
People normally go with the two most recent pay stubs if they have a lower salary than what they made last year. If your salary is the same, using the AGI is normally the preferred way.
If you file jointly, they will use your income in the calculations, whether it be via tax return or pay stubs. This article might help you evaluate your situation: https://studentloansherpa.com/taxes-student-loans-married-filing-jointly-married-filing-seperately/
What if you already have your own student loans in the REPAYE plan, and acquire new parent plus loans for your kid? I assume you can consolidate just the parent plus loans, then use the ICR plan for just those, but how will that affect the payment? Will the REPAYE plan take the ICR plan into account when calculating the monthly payment?
Very interesting questions.
First thought: be careful not to combine your Parent PLUS loans with your other student loans in a federal consolidation. If you do that, then your other loans lose eligibility for repayment plans like REPAYE.
How did your loan servicer say they would be calculated if you are on both ICR and REPAYE?
Right, those REPAYE loans are almost halfway to PSLF, so those won’t ever be reconsolidated with anything. But my daughter doesn’t start school until August, and I don’t have the parent plus loans quite yet, so I don’t know how my loan servicer will calculate the payment payments. I was hoping there was a straight forward answer, but i’ve been unable to find out any info anywhere. It’s as if no one in an IDR payment plan has ever had parent plus at the same time, lol.
I had to do the parent plus loan for my daughter. The loan is $30,000. It was supposed to be my daughters loan. We told the college that. We were ignorant to the process. Instead it all appears in my name like i went to college. I make $43,000 my wife does not work. I have a son that wants to go to college but i dont have the money to make payments on the first loan. Now my daughter dont have to pay anything because its not in her name. What kind of messed up deal is this and now what? File bankruptcy?
Bankruptcy is a difficult option. It is hard to succeed in a bankruptcy case on student debt, but it is possible.
You might benefit from signing up for an income-driven repayment plan. Your loan servicer can talk you through the process. It won’t make the debt disappear, but it will help you stay current on the payments. Rather than paying based upon what you owe, an income driven repayment plan will determine payments based upon what you can afford to pay.
I just found out that I am in the same boat. My son owes $69,000 and I was told that it is totally my responsibility. They have already taken my Federal tax return and are now telling me that they are going to garnish my wages ($250 a week) and then take my Social Secrurity when I retire next year, I am financially ruined because of this loan.
Does overtime count as discretionary income or just base pay?
Overtime will increase your yearly income, so it shows up on your AGI in your tax return. If you document your income with paystubs and have overtime on the paystubs, expect it to increase your discretionary income.
Can you go over the tax implications of student loan forgiveness? I currently owe above 100,000. Based on a student loan calculator I may have close to 300,000 in forgiveness based on the interests rates for 25 years. I would like to know how to determine how much I will have to pay in taxes in an amount like this.
Projecting the exact amount of the tax decades from now is nearly impossible given how income can change over the years, and tax rates also change. This article does offer some additional thoughts on planning for this issue: https://studentloansherpa.com/preparing-ibr-tax-bomb-student-loan-forgiveness/