Optimize Your Taxes and Lower Student Loan Payments

With approximately 42.7 million federal student loan borrowers as of Q4 2024, millions of Americans are searching for ways to manage their finances effectively. Rising loan obligations and tax burdens can feel overwhelming, but strategic planning can make a difference.

At KB Tax Deviser CPAs, we aim to equip you with actionable strategies that reduce tax liability and help lower student loan payments.

Understanding the Link Between Taxes and Loan Payments

Federal student loan payments under Income-Driven Repayment (IDR) plans are directly tied to your discretionary Income, calculated based on your Adjusted Gross Income (AGI). Reducing your AGI can lead to lower monthly payments, easing your financial load.

Income-Driven Repayment Plans and Tax Implications

What Are Income-Driven Repayment (IDR) Plans?

Income-Driven Repayment (IDR) plans are also designed to make federal student loan payments more manageable by basing them on your income and family size. These plans also cap your monthly payments at a percentage of your discretionary income, typically ranging from 10% to 20%.

There are four main types of IDR plans:

1. Pay As You Earn (PAYE): Payments are generally 10% of discretionary income, with loan forgiveness after 20 years of qualifying payments.
2. Revised Pay As You Earn (REPAYE): Similar to PAYE but with some differences in eligibility and spousal income considerations.
3. Income-Based Repayment (IBR): Payments are 10% to 15% of discretionary income, depending on when the loan was taken out, with forgiveness after 20 to 25 years.
4. Income-Contingent Repayment (ICR): Payments are 20% of discretionary income or what you would pay over 12 years on a fixed payment plan, whichever is lower.

Moreover, the primary benefit of IDR plans is that they offer more affordable payments, especially for borrowers with low or moderate incomes. Additionally, any remaining balance on the loan is forgiven after 20 to 25 years of qualifying payments, depending on the plan.

How Adjusted Gross Income (AGI) Affects Monthly Payments

Your Adjusted Gross Income (AGI) plays a critical role in determining your monthly payments under an IDR plan. AGI is your total gross income minus specific deductions, such as contributions to retirement accounts, health savings accounts (HSAs), and other eligible expenses.

Moreover, since IDR plans calculate payments based on discretionary income (which is derived from your AGI), a lower AGI results in lower monthly payments, here’s how it works:

• Discretionary Income Formula: Discretionary income is the difference between your AGI and 150% of the federal poverty guideline for your family size and state.
• Lowering Your AGI: By strategically reducing your taxable income, you can also reduce your discretionary income, leading to smaller monthly payments under an IDR plan.

Strategies to Lower AGI and Student Loan Payments

Consider implementing strategic financial moves to lower your AGI and reduce student loan payments. The key points are outlined below:

1. Maximize Pre-Tax Retirement Contributions

Boosting your retirement savings prepares you for the future and lowers your current AGI.

• 401(k), 403(b), and 457 Plans: Contribute up to $23,000 for 2024 and $23,500 for 2025.
• Traditional IRAs: Maximize contributions of up to $7,000 for 2024 and 2025.

Tip: Traditional (pre-tax) contributions reduce AGI, while Roth (post-tax) contributions do not.

2. Contribute to a Health Savings Account (HSA)

HSAs offer a triple tax advantage: contributions, growth, and qualified withdrawals are tax-free.

• Self-only coverage: Up to $4,150 in 2024 and $4,300 in 2025.
• Family coverage: Up to $8,300 in 2024 and $8,550 in 2025.

3. Utilize Flexible Spending Accounts (FSAs)

FSAs allow pre-tax savings for healthcare and dependent care expenses.

• Healthcare FSA: Contribute up to $3,200 in 2024 and $3,300 in 2025.
• Dependent Care FSA: Contribute up to $5,000 annually ($2,500 if married filing separately).

Caution: FSAs are “use-it-or-lose-it,” so plan contributions carefully.

4. Claim the Student Loan Interest Deduction

Deduct up to $2,500 in student loan interest paid, subject to income limits.

• For 2024, the deduction phases out for a Modified AGI between $80,000 and $95,000 (single) and $165,000 and $195,000 (joint filers).

Example: Real-World Impact

Thomas and Brenda, a married couple with two children, have an AGI of $100,000. Thomas owes $125,000 in federal student loans under the Income-Based Repayment (IBR) plan, which calculates payments as 10% of discretionary Income.

• Current Scenario:
  • Federal Poverty Line (FPL) deduction for a family of four (150%): $46,800.
  • Discretionary Income: $100,000 – $46,800 = $53,200.
  • Annual Payment: 10% of $53,200 = $5,320 ($443/month).
• After Implementing Strategies:
  • Retirement contributions: $8,000.
  • HSA contributions: $4,000.
  • New AGI: $100,000 – $8,000 – $4,000 = $88,000.
  • New Discretionary Income: $88,000 – $46,800 = $41,200.
  • Annual Payment: 10% of $41,200 = $4,120 ($343/month).

By reducing their AGI, Thomas and Brenda save $100 monthly on student loan payments while lowering their tax liability and investing in their retirement.

Conclusion

Lowering your AGI through strategic financial planning can yield significant benefits, including reduced tax burdens and lower student loan payments. By maximizing retirement contributions, leveraging HSAs and FSAs, and claiming deductions, you can achieve long-term financial stability while addressing immediate financial needs.

Ready to optimize your taxes and student loans? Contact KB Tax Deviser CPAs today for a personalized strategy that works for you!