HomeIRSStudent Loan Forgiveness Plan May Lead to a 'Huge Tax Bomb'

Student Loan Forgiveness Plan May Lead to a ‘Huge Tax Bomb’

It may seem like a win-win situation for students when student loans are forgiven through income-driven repayment. Your paycheck is used to match the monthly payment size, which disappears after a certain number of times.

However, a new NerdWallet analysis indicates that most borrowers will not see their loans forgiven, despite promises that they will, Bussiness Hala reported.

The number of federal loan borrowers who make these income-driven monthly payments shows that even when they make their payments, most will pay off their debts before their forgiveness date, and those who do not discharge their debts will still pay them off. The tax increase will affect thousands of people.

Despite the fact that income-driven plans are excellent for borrowers who are unemployed or want to shrink their payments, they are not the best way to pay off the debt in the long run – especially for borrowers who earn more than $30,000.

After more than two years of pandemic tolerance, student loan payments will resume on May 2. Income-driven repayment (IDR) might be the right option for millions of borrowers who are considering their repayment options.

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In what Way is Income-Driven Repayment Going to be Effective?

In 2021, 33% of all borrowers of federal student loans will be enrolled in Income Driven Repayment Plans according to federal statistics.

Revised Pay As You Earn or Repay is the IDR plan which you can access. Discretionary income is paid at 10%. You will now have to repay graduate loans over a period of 20 years, or 25 years without graduate loans. Upon completion of your term, if you haven’t paid off your loan, the remaining amount will be forgiven.

IDR can reduce a borrower’s monthly payments, but whether they’ll ever be forgiven depends on the principal, interest rate, and income over time.

“We’ve Heard About Affordability [IDR payments], but that is not the root; It’s the promise that you won’t be stuck in debt for the rest of your life—that’s the piece that hasn’t quite been hit,” said Persis Yu, policy director and managing attorney at the Center for Student Borrower Protection.

In September 2021, the National Consumer Law Center and the Student Borrower Protection Center reported that only 32 borrowers had been discharged through IDRs since the program began in 1995.

Borrowers currently enrolled in IDRs are mostly part of the Repay program, which was launched in December 2015, though it is not expected to end until at least 2035.

Most Borrowers Will Not Qualify for Forgiveness

Among the circumstances that could cause or delay payments, according to NerdWallet, are payment halts, loss of income, wage freezes, or including a spouse’s income in the borrower’s calculation.

A closer look:

In the analysis, only two groups of borrowers are likely to get their loans forgiven on a $27,000 loan. Furthermore, an individual earning a starting salary of $20,000 will earn $19,128 in interest and still pay $6,280 in income tax on forgiven loans totalling $31,027. For a borrower earning $30,000, interest over the course of the loan will total $15,164, and the principal will be forgiven only for $193.

For a borrower earning $40,000, it will take 149 months (12.4 years) to pay off the loan. Those with $100,000 starting salaries will pay off their loans in 42 months – only 3 and a half years.

Starting salary (increase of 3% annually) Months till the loan is repaid total borrower pays
$40,000 149 $35,286
$50,000 106 $33,021
$60,000 81 $31,324
$70,000 66 $31,044
$80,000 55 $30,123
$90,000 47 $29,303
$100,000 42 $30,275

Borrowers with low incomes are most likely to benefit from the IDR waiver. It is clear, however, that this group of borrowers would not be nominated. Researchers from Third Way, a nonpartisan think tank, found that very low-income people ($12,500 or less) are less likely to enroll, despite the fact that they would most benefit. According to the study, IDRs are most likely to be enrolled by borrowers with student loans of over $50,000.

The study’s co-author and assistant professor, Daniel Collier, said most people can use income-driven repayments when their payments can be paid at traditional times.

“Forgiveness isn’t as generous as people like to think it,” says Collier. “Most people who could afford to pay off debt on time and in the traditional way are really just buying insurance.”

Forgiveness isn’t Cheap

You’ll earn a ton of interest even if you see your loans forgiven.

During their 25-year repayment period, a borrower with a $20,000 starting salary and $129,500 in student loans would have earned $132,457 in interest alone, but would have forgiven $237,338 in principal and interest.

An individual making $50,000 as a starting salary and taking out the same amount of loan would be forgiven $162,708 in principal and interest, but would have earned $167,205 in interest alone over time.

An individual earning $80,000 would have been forgiven $26,727 of their principal and interest over time, but would have been earning $140,601 in interest.

Tax Burdens May be Increased for Borrowers

At the moment, amounts forgiven through income-driven repayments are not taxable by the government until the end of 2025. You may face a costly downfall, if you reach forgiveness after that.

You will owe more to the government because the forgiven amount is added to your total taxable income. Consequently, you will likely pay more taxes.

“Once you are down the IDR rabbit hole, there is no incentive to jump out, but borrowers know this huge tax bomb is coming down in a few years and they have to pay that bill. Will have to do that too,” Collier added.

In the example above, a borrower making the starting salary of $40,000 at the time of forgiveness would shift from the 22% to the 32% tax brackets, assuming today’s tax bracket distribution. In the absence of the forgiveness, this borrower would owe a total of $13,637 in current dollars on his income; with the pardon, he would owe an additional $21,237.

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Using Income-Driven Repayment is Still a Good Idea If You Need It

Enter your loan information into Federal Student Aid loan simulator. This will help you get an idea of how much you might have to pay per month under an IDR plan. The IDR scheme can be enrolled at any time. Each year, your income must be re-certified.

While IDR may not offer forgiveness effectively, it certainly provides a safety net when you:

You should not use income-based repayment (when you):

Re-certify when (you):

Apply online at studentaid.gov Or fill out a paper form. On the Federal Student Aid website, you can see a application process video.

Borrowers can self-report their income without submitting tax documents when applying for income-driven repayment up until July 31, 2022.

You will be notified when your application is complete and informed about your new monthly amount.

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