One of the major perks of having federal student loans is that there are several repayment plans based upon what you can afford to pay rather than what you owe. Borrowers on these income-driven repayment plans have student loan bills based upon their discretionary income. One of our readers, Daphne, is concerned about her student loan payments going up due to an inheritance she is going to receive. If you have a question for the Sherpa, feel free to ask us!
Dear Student Loan Sherpa,
Thank you so much for this amazingly helpful resource. I have spent hours scouring articles and forum questions, and although I have gleaned and confirmed valuable information, the topic of my question has not been directly addressed. I am on year 3 of a 25 year IBR plan. (15% discretionary income and 25 years to forgiveness). Currently my payments are at zero as I have not been working due to illness.
If I were to either inherit, or be gifted a large lump sum, (larger than the loans total, which has grown to about 75k because of capitalized interest), how would that affect my payment plan for that year and on going? I have spoken to 5 different people, both at the Dept of Ed itself and my servicer Nelnet, who all said the same thing but could not direct me to where I could find the answer in writing. I was told that since inheritance or gift is not considered income, that it would not affect my repayment. I understand that if the lump sum is invested, the accrued income would then be considered income.
When we talk about income-driven repayment plans, such as IBR, one of the key benefits is the fact that the plans are designed so that borrowers can afford their student loan payments regardless of how much they owe. Daphne thinks, quite reasonably, that if she gets a large inheritance or financial gift, she would be expected to pay more towards her student loans.
Fortunately for Daphne, the formula that the government uses for determining how much you can pay is pretty simplistic. They consider your state of residence, family size, and most recent tax return. Using this information, your loan servicer calculates your discretionary income, and from that number, your monthly payment. To see this calculation in action, be sure to check out the Department of Education’s Repayment Estimator.
Adjusted Gross Income
The key figure on your tax return is the adjusted gross income. As this number goes up, your income-driven student loan payment increases. If it goes down, your student loan bill will drop.
Daphne’s question comes down to a tax question. Does an inheritance or financial gift have an impact on your adjusted gross income? If the inheritance is treated as income, it will increase her student loans. If it isn’t taxed, there will be no impact on her student loan payments.
Inheritance Taxes and Student Loans
To find out for certain whether or not an inheritance or financial gift will increase your student loan payments, you will need to talk to an accountant. The accountant who prepares your tax return will know for sure whether or not it will increase your AGI.
Generally speaking, inheritances are not taxed on the beneficiary. This mean that the person giving the money has to pay tax on it, not the one receiving it. We recently discovered the same thing when looking at gift taxes as well.
However, it is worth noting that even if is not taxed at the federal level, there still might be state taxes, depending upon where you live. The good news is that even if there are state taxes, it won’t change your student loans.
The system for calculating a borrower’s ability to make student loans is fairly simple. It all comes down to the AGI on your most recent tax return. In Daphne’s case, this is a major benefit because it means an inheritance likely won’t increase her student loan payment.