Key Takeaways
Single borrowers making under $125,000 a year and couples making less than $250,000 a year generally qualify to have up to $10,000 in student loans forgiven.
Applications for relief will be available in mid-to-early October.
Debt relief is not considered taxable income on your federal income tax return, but some states may try to tax it. Check with your advisor.
As fall semester classes resume at thousands of colleges and universities nationwide, there’s more than the usual back-to-school excitement. President Biden recently announced that he will cancel up to $10,000 in federal student loan debt for individual borrowers making under $125,000 a year or couples making less than $250,000 a year. That income threshold applies to 95% of U.S. households according to U.S. Census data.
When you consider that the average student loan balance is $37,667 according to the most recent data provided by the Department of Education’s Federal Student Aid Office, this news was greeted with a mix of excitement and confusion as government relief programs so often are.
Even if a child or grandchild in your life owes a lot more than $37,000 in student loans, it pays to look into this relief program. From a broad perspective, at an average interest rate of 5.8%, your $10,000 worth of loan forgiveness is equivalent to a savings of $17,381 over 10 years.
Who qualifies for loan forgiveness?
The loan relief program applies to federal student loans held by current and past students, regardless of age, provided the borrower has an annual income of less than $125,000 (single) or under $250,000 for married couples or heads of households. Your most recent tax return will be used, so for most borrowers, that’s your 2021 return. If you are a current student and a dependent of your parents but have loans, you will use your parents’ tax return and AGI figure. Loans awarded to current students and graduates with undergraduate, graduate and Parent PLUS loans are eligible as long as the loans were awarded by June 30, 2022. This does not include private loans that you may have (through Sallie Mae, for example).
How to apply for relief
The application will be available in early-to-mid October, officials said. Borrowers who provide an email address at studentaid.gov will receive an email notification when the application is available. Applications can take four to six weeks to process. The pause on federal student loan repayments terminates Dec. 31, 2022. Be sure to complete the application by mid-November so it can be processed before the pause ends.
Nearly 8 million borrowers may be automatically eligible to receive relief because relevant income data is already available to the Department of Education. Another 2 million borrowers are those who recertified their income as part of an income-based repayment plan. But the Department of Education likely doesn’t have income data for millions of other borrowers it hasn’t been required to update it during the student loan payment pause.
Again, if the Department doesn’t have your income data, complete the application on studentaid.gov. Keep an eye on your balance by visiting your loan servicer’s website beginning in October. It certainly doesn’t hurt to fill out the application just to be safe.
Is student loan debt relief taxable?
No, student loan debt relief will not be treated as taxable income on your federal income tax return, according to the White House. This rule was established by the American Rescue Plan of 2021, which specified that student loan forgiveness would not be taxed through 2025. Although most states conform to the federal rules, 13 states could potentially tax the amount of forgiveness, including Pennsylvania, New York, Massachusetts, Arkansas, Hawaii, Idaho, Kentucky, Minnesota, Mississippi, South Carolina, Virginia, West Virginia, and Wisconsin. No concrete guidance has been issued to date, but it’s something to bring up with your advisor as the debt relief program moves forward.
Making payments more manageable
To address concerns about monthly payments, the Biden administration is proposing a rule to reduce the monthly payment amount from 10% to 5% of a borrower’s discretionary income – i.e., income after taxes and other living expenses. Also, the relief program would forgive loan balances of $12,000 or less after 10 years of payments, instead of the current 20 years. This part of the announcement is yet to be solidified, and there are some gray areas as far as which repayment plans the reduction would qualify for.
Real-world Example I am working with a young couple who graduated from college in 2014 and went onto careers in the insurance industry. Since their career path did not require graduate education, they didn’t saddle themselves with huge loans. However, they each graduated with $30,000 to $40,000 in student debt.
Being financially responsible, they had been paying off their loans diligently according to their 10-year repayment plan. They got married in 2019 and now have a combined income of about $225,000. However, as part of the Biden Administration’s COVID relief campaign, they elected to start halting payments on their loan balances in March 2020 with just under $10,000 outstanding each.
This was a deliberate decision we helped the newlywed with, taking into account their entire cash flow picture. The couple continued to save (rather than spend) the money that would have been going to student loan payments every month, knowing that they could always resume paying off the remaining loan balance before the interest restarted. And if the loan balance was forgiven, as we now see, that resulted in a nearly $20,000 bonus in their favor. It turned out to be a smart decision and the young couple is excited about investing the cash they saved up during the pandemic.
Conclusion
Since education financing is a high priority for our firm, we are constantly monitoring the student loan debt relief program and will keep you posted as the initiative takes shape. If you or a family member has questions about eligibility or requires guidance on recent loan payment reimbursement or potential tax implications, please give us a call.
BRENDEN LEESE, CFP® is an Associate Wealth Advisor at Novi Wealth Partners