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Sheltering Income for lower Student Loan Payments

It is possible for student loan borrowers to have income excluded from their income-driven repayment plan calculations.

Written By: Michael P. Lux, Esq.

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If you are on an income-driven student loan repayment plan, such as IBR, PAYE, or SAVE, you may know that your payments are based upon your “discretionary income.” Clever minds may wonder what exactly is “discretionary income” and how do I lower it so that I can get lower payments.

One of our readers had this thought in mind when submitting the following question:

I’m looking at the REPAYE program and am curious how the “shelter” portion of one’s expenses is subtracted (along with taxes) to arrive at discretionary income, which serves as the foundation for the 10% max payment. Do you simply provide a mortgage/renter’s statement to your lender?

Mortgage, Rent, and Discretionary Income

Unfortunately, monthly bills don’t get factored into the “discretionary income calculation. This means that you do not need to submit your monthly mortgage or rent payments for your discretionary income calculation. The logic behind your question makes sense… more money spent on housing means less truly “discretionary” income. Sadly, this is not how the calculation is done. Whether you live in a very expensive area, such as San Fransisco or New York, your payment is calculated the same as someone living in an area with a very low cost of living.

While expenses like housing, child care, and utilities do not enter the equation, there are several ways to reduce or shelter your income so that payments are smaller. The first thing to understand is the straightforward formula for discretionary income.

The Government’s Idea of “Discretionary” Income

The government defines discretionary income as the money you make above 150% of the poverty level (for borrowers on SAVE, this number is bumped up to 225%). These numbers are the same for the 48 contiguous states. The only way the poverty level changes from one person to the next is based on family size. Adding a child to the family will reduce student loan payments, but this approach is probably not the most efficient way to save money.

The process is simple; you look at a table that has a number on it. Every dollar earned beyond 150% of the federal poverty level considered to be discretionary.

For further reading, be sure to check out our guide to calculating your discretionary income.

The gray area enters the equation when it comes to determining income…

Sheltering Your Income

Even though the non-discretionary part of the calculation leaves no wiggle room, there are still ways to reduce your monthly student loan payment on the income-driven plans.

The key here is lowering what the government defines as your income. When most people certify their income for IBR, PAYE, or SAVE, their lender will get authorization to access their most recent tax return. The key figure on this tax return is the AGI, or Adjusted Gross Income. As this number is lowered, your monthly student loan payment is lowered.

One of the best ways to reduce AGI is to make contributions to your 401k account. Not only do you not pay tax on the contributions to the 401k, but it also lowers your AGI. Another deduction that might help is the student loan interest deduction.

However, not all tax deductions lower your AGI. The deductions to keep an eye out for are called above-the-line deductions. This is the term that the tax people use to describe deductions that reduce your AGI.

One last thing to keep in mind is spousal income. If you are on SAVE, IBR or PAYE, you can file your taxes separately, and your spouse’s income won’t factor into your monthly payment. However, if you file jointly, your spouse’s income will be included.

The strategies to shelter income mirror some of the strategies used to lower your tax bill.  Our student loan tax strategy article breaks down the many tactics that can be used to create some flexibility with student loan payments.

Has your income temporarily increased? If your income was large for just one year, there are other options to hide the one year of increased earnings.

The Bottom Line

The way the government determines your monthly payments on the income-driven plans is pretty straightforward. It may be worse for some than others, but it leaves little room for debate as to what is included in your discretionary income.

Savvy borrowers may be able to save a little extra for retirement, but ultimately, legitimately “sheltering” your income from student loan payments is a part of your yearly tax strategy and something worth discussing with an accountant.

About the Author

Student loan expert Michael Lux is a licensed attorney and the founder of The Student Loan Sherpa. He has helped borrowers navigate life with student debt since 2013.

Insight from Michael has been featured in US News & World Report, Forbes, The Wall Street Journal, and numerous other online and print publications.

Michael is available for speaking engagements and to respond to press inquiries.

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