Tax season is obviously important for a number of reasons, but few people realize the tremendous impact that your tax return can have on your yearly student loan payments. Each year, borrowers enrolled in the IBR (Income-Based Repayment) and PAYE (Pay As You Earn) repayment plans, must submit evidence of their yearly income.
Most people use their most recent tax return as evidence of their income. The loan servicer calculates your required payment based upon your AGI (Adjusted Gross Income). Therefore, the lower your AGI, the lower your required minimum student loan payments will be for the following year, assuming you are on IBR or PAYE.
How do I lower my AGI?
Tax breaks that lower your AGI are commonly known as Above-the-line deductions. With each above-the-line deduction that you get credit for, your AGI is lowered, and in turn your monthly student loan payment is lowered.
Here are a few examples:
- Contributions to a Traditional IRA
- Interest paid on student loans (this would include private student loans)
- Health Savings Account contributions
- Certain moving expenses
A Special Consideration for Married People
If you are married and on IBR or PAYE, it is especially important to think about your student loans when you do your taxes. If you file as married filing separately, your spouses income will not be considered when calculating your monthly student loan payments. However, by filing jointly, you will qualify for tax breaks especially for couples. As a result of these competing interests, it is critical to do the math and weigh the pros and cons of each option. This site previously explored this issue in more detail.
Using this info to your Advantage
If you are on the fence about starting a traditional IRA and wondering whether or not you can afford it, think about it in terms of your student loans AND your taxes. Putting some money away in that IRA not only will lower your taxes, but it will also lower your monthly student loan payments.
If you are on IBR or PAYE, your yearly taxes will determine far more than whether or not you get a refund in April… your taxes will determine exactly how much money you will owe on your student loans. This is a critical detail that must not be overlooked in tax time. If you have someone helping you with your taxes, be sure they understand how the decisions made will impact your payments. If you are doing your taxes, be sure to do the math on all the possible options you have at your disposal. Being smart about your taxes and your financial planning can save you money on student loans year round.