The idea behind Income-Driven Repayment (IDR) Plans like PAYE and IBR is that as borrowers earn more money, they pay more towards their student loans each month.
The plans are designed to keep federal student loan bills affordable.
If you have a particularly high-earning year, this can complicate your repayment strategy.
Fortunately, several strategies can essentially bury a high-earning year from impacting your student loan payments.
Items that Might Cause an Unusually High Earning Year
Before jumping into the strategies to keep your student loan payments reasonable, it’s probably a good idea to discuss a few examples of items that might cause a big year.
Overtime – Not all businesses have a steady 40-hour week. If you had a ton of extra overtime one year, it could impact your student loan payments.
Selling Your Business – If you’ve built a successful business and sold it to someone else, your income could be unusually large the year you sell the business.
A One-Time Bonus – If you have a typical yearly bonus that happens each year, it won’t be a factor. However, if you have a one-time bonus from your company or a huge annual bonus, you may want to exclude it from IDR calculations.
Withdrawing money from a 401(k) or Traditional IRA – Some withdrawals from retirement accounts are taxed. If you pull money out of a retirement account, your income for that year might seem exceptionally high.
A Temporary Promotion – If your boss leaves the company and you fill in while they find a permanent replacement, you might earn some extra money in that year.
Finally, if you get married or divorced or change from filing separately to filing jointly for a year, you might have an unusually high-income year.
Sherpa Tip: This list could go on for days. The items included serve as examples, but there could be any number of reasons that you have an unusually high-income year.
Calendar Gymnastics to Hide a Big Year
IDR payments are calculated based on your most recent tax return.
Suppose you recertify your income each March. If the previous year was unusually low, it’s a good idea to file your taxes early so that the low year is on file when you recertify. Alternatively, if your income was high the last year, you can delay filing your taxes until April. The following year, you can file early, and the high earning year never impacts IDR payments.
If you want to take this strategy to the extreme, you could request an extension to file your taxes. The IRS allows taxpayers to delay tax filing until October 15.
By watching your filing timeline, you can use lower earning years twice and essentially bury a big year.
Alternative Documentation of Income
Suppose you pulled money out of your 401(k), so your most recent tax return shows an income that doesn’t remotely resemble what you actually earn.
On your IDR Recertification Application, there is a question that asks if “your income significantly decreased since you filed your last federal income tax return.” By marking yes, you trigger alternative documentation of income.
Alternative documentation of income means that the Department of Education will use something other than your most recent tax return to calculate your IDR payments.
For most borrowers, this means using two recent paychecks to show what you actually earn. If you are self-employed or have another unique circumstance, you may have to work with your servicer to find proper documentation of your income.
Going this route ensures that your big tax bill doesn’t also mean higher student loan payments for a year.
Hiding Income from IDR Calculations
Sometimes the previously listed strategies are unavailable. You may have also gotten a raise, which means a larger income for many more years.
In this circumstance, it is harder to exclude the additional money from impacting IDR payments. However, it is still possible.
My favorite tactic is to hide the money away in a retirement account.
If you put money in a 401(k) or Traditional IRA, it lowers your tax bill. The reduced tax bill means lower IDR payments. It also means more money set aside for retirement. For the borrowers that can swing it, hiding money away in a retirement account has significant advantages.
Tax Bills and IDR Student Loan Payments
All borrowers should understand the critical relationship between IDR payments and yearly taxes.
As your AGI increases, your student loan payments eventually increase.
If you can find a way to lower your AGI or adjust your IDR recertification/tax timeline, you impact IDR payments.
In other words, it’s critical to think about student loans at tax time.
