Hundreds of thousands of Americans use federal income driven repayment plans to help pay off their student loan debt. Traditionally, there were four different plans:
Income Contingent Repayment (ICR)
Revised Pay as You Earn (REPAYE)
But recently, President Biden's administration announced a replacement for REPAYE, known as the SAVE plan. It will have provisions within it to further lower payments for those that qualify.
The problem with IDR as a whole, though, is that calculating what you'll pay each month can be difficult, and it may even be different depending on which IDR plan you pick. All of the calculations, though, are based on a premise known as discretionary income, which we'll explore today.
Student loan discretionary income calculator
Below is a discretionary income calculator to help you understand how your student loan payments may be calculated on an income driven repayment plan. Then, below the calculator, learn more about the calculation, IDR, and what it may mean for you.
This calculator does make a couple of assumptions that you should be aware of.
First, it assumes that you live in the 48 contiguous United States (not Alaska or Hawaii). If you live in one of those states, check back to this piece soon for updated calculators to help you out.
Additionally, this calculator is not yet equipped to handle the new SAVE IDR plan. Updates will be made soon.
Finally, your discretionary income will not be your student loan payment. Rather, your monthly payments will be 10 or 15% of this value, depending on which IDR plan you ultimately use.
Also, if your resulting discretionary income figure is negative, it typically means that the United States government will set your projected monthly payments to $0.
What is discretionary income anyway?
Your discretionary income is a calculation completed by the United States government to determine how much those on income driven repayment plans can afford to pay towards your student loans each month. This calculation takes a number of variables into account, including your household size (number of dependents), annual income, and where you live.
How to calculate discretionary income
Under these guidelines, your discretionary income is equal to the difference between your annual income and 150% of the poverty line, given your location and household size. This figure will be adjusted to 225% with the new SAVE plan, which will lower participating borrowers' expected monthly payments.
Generally, you'll pay either 10% or 15% of your discretionary income towards your student loans each month.
Income driven repayment plans require you to re-certify your income annually so that your new payment amount can be adjusted each year.
If you make less than the previous year, your payments will likely decrease. If you make more, you can generally expect your payments to increase, though it will depend on updated poverty line data, which is provided by the Department of Health and Human Services (HHS).
What is income driven repayment?
As a reminder, income driven repayment is a type of student loan repayment plan that oftentimes ends in forgiveness after participating borrowers make between 20-25 years of reduced monthly payments.
By reducing monthly payments, borrowers are able to maintain cash flow to pay their other bills, save for retirement, and enjoy life.
After making the 20-25 years of payments (varies by program), your remaining balance is forgiven, though this forgiveness may be treated as taxable income.
Check out my specific IDR plan articles below:
Remember, the new SAVE plan will replace REPAYE, and other IDR plans will be phased out in time.
Benefits to the discretionary income calculation
There are actually some positives to the way in which your expected monthly payments are calculated.
1. Takes into account your income and national trends
First, they take into account your income and macro-economic conditions as a whole. And while no system is perfect, this approach seems fair. For example, if you made the same money in 2022 that you did in 2021, your payments for 2023 likely would have declined anyway, given the increases in the poverty line as a result of inflation.
2. Changes annually
If you're upset that your expected payments don't match the reality of your financial picture, you'll only be stuck with them for twelve months, until you re-certify your income. Just keep in mind that, barring any unusual circumstances, your payments will trend upwards over time if your income increases.
Cons to the discretionary income calculation
Neither the discretionary income formula, nor any other equation that could take its place, will ever be perfect. Here are a couple cons.
1. Treats contiguous United States the same
Earlier, I mentioned that the discretionary income formula will take into account where you live. This is true, to a point. For some reason, Federal Poverty Guidelines set by HHS lump borrowers into one of three areas:
Alaska
Hawaii
Contiguous United States
Alaska and Hawaii have vastly different costs of living and average incomes than the lower forty-eight, but there are also discrepancies nearly this large across other states. For instance, under this logic, California and Kentucky are treated the same, even though California's cost of living and average income are much closer to resembling that of Hawaii.
This disadvantages those living in higher cost of living states, where the poverty line is likely to be reached at a higher income.
2. Doesn't account for total financial picture
Another issue with the discretionary income calculation is that it doesn't account for the totality of someone's life.
I get it. It would be nearly impossible to create a formula to take into account every aspect of someone's financial picture. But the lack of wiggle room may also be disconcerting for some.
The counterargument would be that some of these borrowers, like those dedicating their lives to public service, have other avenues beyond income driven repayment plans.
Lower your discretionary income
Those that understand the premise of discretionary income can actually use it to lower their student loan payments. Since your IDR payments will be based off your annual adjusted gross income (AGI), those that are effective at lowering their AGI will be able to pay less each month.
There are a number of legal ways that borrowers may be able to lower their AGI, effectively bringing it closer to the poverty line (resulting in lower monthly payments).
1. Make contributions to retirement accounts
Contributing to certain retirement accounts, such as 401(k)s and Traditional IRAs (for those under the income phaseout) can lower your AGI. In my opinion, this is a huge win. Getting to save money and at the same time lower my discretionary income? Yes please!
2. Contribute to a Health Savings Account (HSA)
Additionally, those that are on high deductible health plans (HDHPs) may be able to further lower their student loan payments by making contributions to a Health Savings Account (HSA).
HSAs allow you to save and invest for current and future healthcare expenses, a must for those on HDHPs with higher out of pocket costs.
3. Take the student loan interest deduction
Eligible borrowers may also be able to deduct some or all of their student loan interest, up to $2,500 per year.
Available for both federal and private debt, it can be a great way to lower your AGI.
Still, there are other strategies that you can use to lower your IDR payments, including:
Itemizing your deductions if it makes sense
Taking any eligible self-employment deductions
Writing off investment losses (up to a limit)
None of this is official tax advice, but strategies that can help you pay less on income-driven repayment. Always consult with a tax professional to determine what your best course of action is.
Conclusion
Knowing how the government calculates discretionary income is a great first step in identifying whether income driven repayment may be a good idea for you and your student loans.
Plus, using our calculator will make this process effortless and help you to make the right decision. Now, I want to hear from you. Does anything about this calculation surprise you? Is income driven repayment a good option for you? Why or why not?
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