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Planning for Potential Student Loan Forgiveness

Last week President Biden delivered on his long-awaited campaign promise of broad-based student loan forgiveness just one week before the latest payment pause was set to expire. Let’s take a look at what the announcement consisted of, and what it could mean for you.

The Basics

As widely anticipated, President Biden’s plan is set to cancel $10,000 worth of student debt for each individual federal borrower, with an additional $10,000 being cancelled for those borrowers who were recipients of Federal Pell Grants, a form of need-based aid awarded to undergraduate students who display exceptional financial need. This forgiveness is limited to individual borrowers earning less than $125,000 per year ($250,000 for married filing jointly).

In addition, the latest iteration of pandemic driven payment pauses has been extended through the end of 2022, with no payments due or interest accruing for the rest of the year.  

Included in the announcement, aside from the forgiveness component, was a proposal that revises the structure of existing income-driven repayment plans. This proposal would cap monthly payments at 5% of discretionary income, down from the common 10% threshold in most plans today. Along with the payment cap, the amount of income that is considered discretionary would also be reduced.

A drop in the bucket?

I know what you’re thinking – we all know someone who has amassed far more than $10,000 in student loans – will this even move the needle for the majority of borrowers?

  1. As of July 29th, 2022, the average federal student loan debt balance was $37,667 per borrower.
  2. Of the 43 million borrowers, 32% owe less than $10,000 in federal debt and would essentially have their slate wiped clean. According to a 2019 study conducted by The Institute for College Access and Success, over 52% of borrowers who default owe less than $10,000 on their federal undergraduate debt.
  3. 74% of borrowers owe $40,000 or less, with the balance owing $40,000+

How and when will the forgiveness be applied?

For borrowers that are currently enrolled in an income-driven repayment plan, the Department of Education already has your income on file, and the payment will likely be directly applied. For all other Federal borrowers, it has been confirmed that a simple application will need to be filed with the Department of Education in order to receive the forgiveness.

Planning and Eligibility

Although we know there is an income cap attached to the forgiveness, it has yet to be confirmed whether this cap will be based on the prior year’s income or 2022 income. In the event that 2022 income is used, consider these planning tools as we approach year end if you are close to the cap:

  1. Defer Income – This can be done in several ways, from maxing out your employer-sponsored retirement plan contributions, contributing to an IRA, deferring exercising options, to business owners accelerating deductions to lower taxable income. Consult your wealth advisor and tax professional to explore potential opportunities.
  2. Filing Status – Let’s say I am part of a two-income household in which my spouse is the clear breadwinner, and if filing single, I would be under the income cap for forgiveness based on my income. If the payment cap is based on 2022 income, there is a potential filing separately could allow me to take advantage of the forgiveness that I otherwise would not be able to if filing jointly.  

Refund on Pandemic Payments

Courtesy of the federal student loan repayment pause that began back in March of 2020, borrowers have not been required to make loan payments towards their outstanding balance, nor have they accrued additional interest on their debt.

Let’s imagine someone who is part of the 32% of borrowers that owed less than $10,000 and despite the pause had been diligently making payments toward their principal balance. And now, their $10,000 balance in March 2020 is currently $4,000. A specific clause on the Federal Student Aid website states that “You can get a refund for any payment (including auto-debits) you make during the payment pause. Contact your loan servicer to request that your payment be refunded.”

So, after a few phone calls with their service provider, the $6,000 in payments during the pause should be now refunded to them in cash, bringing their loan balance back to $10,000. After that, assuming they are under the $125,000 per year income cap, they can apply for forgiveness and have the entire $10,000 balance forgiven while simultaneously receiving the $6,000 in payments back. If you find yourself in this unique situation, contact your loan servicer today.

While every situation differs, it’s important to stay connected and weigh all options when it comes to planning around student-loan forgiveness. Reach out to your Wealth Advisor today to continue the conversation.

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