How To Prepare For Biden’s Student Loan Debt Relief Plan

Authors:

Ryan Frailich

Guest Contributor

Ryan Frailich is the CFP, founder of Deliberate Finances, a fee-only financial planning practice that specializes in working with couples in their 30’s, as well as educators and nonprofit workers. Prior to becoming a planner, Ryan was a teacher himself and then worked to grow a charter school organization as the Director of Talent & Human Resources. Given their age and occupations, student loans are a priority for the majority of his clients, so he’s spent many hours trying to find the right ways to provide clients with information about their student loan options. You can find him on Twitter, email him at [email protected], or at basically any New Orleans festival featuring delicious food and drinks.

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Jeffrey Levine, CPA/PFS, CFP®, AIF, CWS®, MSA

Team Kitces

Jeffrey Levine, CPA/PFS, CFP, AIF, CWS, MSA is the Lead Financial Planning Nerd for Kitces.com, a leading online resource for financial planning professionals, and also serves as the Chief Planning Officer for Buckingham Strategic Wealth. In 2020, Jeffrey was named to Investment Advisor Magazine’s IA25, as one of the top 25 voices to turn to during uncertain times. Also in 2020, Jeffrey was named by Financial Advisor Magazine as a Young Advisor to Watch. Jeffrey is a recipient of the Standing Ovation award, presented by the AICPA Financial Planning Division for “exemplary professional achievement in personal financial planning services.” He was also named to the 2017 class of 40 Under 40 by InvestmentNews, which recognizes “accomplishment, contribution to the financial advice industry, leadership and promise for the future.” Jeffrey is the Creator and Program Leader for Savvy IRA Planning®, as well as the Co-Creator and Co-Program Leader for Savvy Tax Planning®, both offered through Horsesmouth, LLC. He is a regular contributor to Forbes.com, as well as numerous industry publications, and is commonly sought after by journalists for his insights. You can follow Jeff on Twitter @CPAPlanner.

Read more of Jeff’s articles here.

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Ben Henry-Moreland

Team Kitces

Ben Henry-Moreland is a Senior Financial Planning Nerd at Kitces.com, where he researches and writes for the Nerd’s Eye View blog, using his experience as a financial planner and a solo advisory firm owner to help fulfill the site’s mission of making financial advicers better and more successful. In addition to his work at Kitces.com, Ben serves clients at his RIA firm, Freelance Financial Planning.

Read more of Ben’s articles here.

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One of the key promises of Joe Biden’s presidential campaign in 2020 was that student loan borrowers would be provided some relief, including a pledge to cancel a minimum of $10,000 of student debt per person. But that pledge went unfulfilled for the first year and a half of Biden’s presidency, leading many to wonder whether changing political winds had dampened the president’s enthusiasm for what would have been an unprecedented step toward reducing the $1.7 trillion of outstanding Federal student loan debt.

On August 24, 2022, however, the Biden administration finally took some long-awaited action on its promise, announcing a sweeping student loan relief program that, among other things, forgives up to $10,000 of student loan debt for borrowers (and up to $20,000 of forgiveness for Pell Grant recipients) under certain income thresholds.

Student Loan Debt Relief Plan: Key Provisions

While student loan forgiveness has been the main focus of many of the headlines announcing the Student Loan Debt Relief Plan, the administration’s proposal bundles together several key provisions that also have relevance to current and future student loan borrowers.

At a high level, these provisions include:

• Cancellation of student loan debt:
  • Up to $10,000 for borrowers with income under $125,000 for single individuals and $250,000 for married couples;
  • Up to $20,000 for Pell Grant recipients, with the same income thresholds as above;
• Another (final) extension of the pause on Federal student loan payments through December 31, 2022;
• Some of the changes originally made by the Public Service Loan Forgiveness (PSLF) Waiver will become permanent provisions of PSLF, even after the waiver ends on October 31, 2022, and will be publicized through an awareness campaign aimed at eligible individuals. These changes will involve allowing credit for late or lump sum payments and for deferment or forbearance for people with qualifying employers (e.g., Peace Corps, military deployment); and
• Creation of a newly proposed Income-Driven Repayment (IDR) plan that limits payments on Federal undergraduate loans to 5% of the borrower’s discretionary income and forgives loans of less than $12,000 after 10 years of payments.

These changes are being implemented via executive action rather than through legislative passage, meaning that, unlike proposed legislation that often undergoes many transformations while winding through committees and debate in both houses of Congress, there are less likely to be substantial changes to the Biden administration’s proposal before its implementation (other than filling in details that have yet to be announced). However, there is a significant chance that Republicans who oppose the plan will try to stop its implementation with legal challenges, meaning that the ultimate outcome might be determined by the courts.

Still, with an estimated 43 million student loan borrowers in the United States – not to mention other stakeholders like spouses, parents, children, and employers who are also affected by a borrower’s student loan debt – the relief plan has the potential to impact a huge number of households, including the clients of many financial advisors. And although many of the plan’s ‘fine print’ details have yet to be released, advisors can still play a critical role in helping their clients to start planning now to make sure they can benefit from these proposals to the greatest extent possible, and to be prepared for action on the more time-sensitive elements when the proposal is finalized.

Cancellation Of Up To $10,000 Or $20,000 In Student Federal Loan Debt

Although advocates for relief had been pushing the Biden administration to forgive as much as $50,000 of student debt per borrower, the administration ultimately settled on lower but still substantial maximum forgiveness amounts. More specifically, borrowers who qualify and are under certain income thresholds (discussed later) will be limited to a maximum forgiveness amount of $10,000. And for borrowers who were recipients of Federal Pell Grant awards, the maximum amount of loan forgiveness is doubled to $20,000.

Although future guidance from the U.S. Department of Education could result in a different outcome, the total amount of an individual’s Pell Grant does not currently seem to be a factor in calculating the maximum forgiveness amount. Rather, receipt of any amount of Pell Grant funding appears to be enough to entitle a borrower to the $20,000 limit.

Notably, the loan forgiveness for borrowers who received Pell Grants isn’t intended to repay the Pell Grants themselves (which generally don’t have to be repaid except under certain conditions). Rather, since Pell Grants are generally provided only to students with “exceptional financial need,” they serve as a rough ‘measuring stick’ for borrowers with greater financial need and/or fewer personal or family resources available to pay down their debt.

Eligibility For Forgiveness Is Based On Taxpayer Income Levels

While many borrowers will qualify for the maximum amount of forgiveness ($10,000 of student loan debt, or $20,000 of student loan debt for Pell Grant recipients), many high-income taxpayers will not be eligible for the relief. Of course, that begs the question, “Who’s a high-income taxpayer?”

The White House Fact Sheet indicates that the income threshold to qualify for forgiveness is $125,000 for single filers and $250,000 for married couples, while a press release by the U.S. Department of Education clarified that the $250,000 threshold also applies to Head of Household filers. While other filing statuses are not mentioned, all indications suggest that they will also be subject to the individual $125,000 threshold amount, including married couples who file separately (which could be particularly significant for the large number of married borrowers using certain IDR repayment strategies, who file separately in order to reduce their monthly loan payments).

While it appears that no definition of “income” has yet been publicly formalized, Income-Driven Repayment (IDR) Plans generally use an individual’s Adjusted Gross Income (AGI) for comparison to the Federal Poverty Limit income. Accordingly, AGI would seem to be the leading candidate for the definition of income here, as well.

One thing we do know for certain, however, is when income matters… or, more appropriately, when it mattered. While neither the White House Fact Sheet nor the U.S. Department of Education Press Release makes any reference to specific dates, an administration official did confirm during a White House Press briefing that the relevant tax years of a borrower’s income are 2020 and 2021.

The good news for borrowers hoping for relief is that the same official confirmed that, although the measuring years are 2020 and 2021, it is not necessary for income to be below the thresholds in both years. Rather, as long as an individual’s income was below their applicable threshold in either 2020 or 2021, they will qualify for the relief.

Example 1: Bryan is a single taxpayer and has $20,000 of outstanding student loans (he was not a Pell Grant recipient).

In 2020, Bryan won $100 million in the lottery.

In 2021, he worked and had an AGI of $124,999.

Since Bryan’s AGI in 2021 was below the $125,000 threshold for single filers, he will be eligible for $10,000 of student debt forgiveness from the Student Loan Debt Relief Plan.

The bad news for some borrowers, however, is that all indications seem to point towards the income thresholds being ‘cliff’ thresholds. In other words, as long as an individual’s income is below their particular threshold, they can qualify for the full amount of relief. But upon reaching the threshold, their entire benefit – up to $10,000, or $20,000 for Pell Grant recipients – is eliminated (similar to the way Medicare Part B/D Income-Related Adjustment Amounts [IRMAAs] work).

Notably, the White House Fact Sheet also states that “No individual making more than $125,000 or household making more than $250,000 – the top 5% of incomes in the United States – will receive relief.” This would seem to provide strong evidence that individuals with just a single dollar of income over the threshold would ‘fall off the cliff’ and receive no benefit at all.

Example 2: Adam is Bryan’s lucky twin brother and is also a single taxpayer with $20,000 of outstanding student loans.

In 2020, Adam also won $100 million in the lottery.

In 2021, Adam worked and had wages of $124,999, but he also won $5 on a scratch-off lottery ticket, which he diligently reported, bringing his AGI to $125,004.

Since Adam’s AGI was not below the threshold for single filers in either 2020 or 2021, he will not receive any student debt forgiveness from the Student Loan Debt Relief Plan.

The use of a cliff threshold could create very interesting dynamics for some borrowers. In some cases, a few extra dollars of earnings could, in hindsight, be the reason an individual failed to qualify for relief. And in other cases, borrowers who earned less in 2020 or 2021 could actually end up in superior financial positions (as Bryan did in Example 1 above)!

Income-Tax Consequences Of Forgiveness

In general, when an individual has debt discharged, the forgiven debt becomes taxable income. Currently, however, thanks to changes made by the American Rescue Plan Act of 2021, most student debt discharged through 2025 (including any debt forgiven by the president’s current proposal) will be tax-free… at least at the Federal level.

At the state level, though, income tax consequences are a whole different ball game. In states with no income tax or where state income tax rules conform to Federal rules, such discharged debt will also be tax-free at the state level. But for some states that do not conform to Federal tax law, the forgiven debt will be taxable at the state level. At least for now.

Given the broad nature of the relief provided by the Biden administration, some states that would normally tax forgiven debt may choose to pass legislation (which they could choose to make temporary or permanent) to make such forgiven debt tax-free at the state level as well. Accordingly, borrowers should keep an eye on their state legislators.

Planning Strategies To Qualify For Forgiveness

Using 2020 and 2021 as the measuring years means that for most borrowers, at this point, there is no planning that can be done to qualify for loan forgiveness. Either their income was below the applicable threshold during those years, or it wasn’t. However, for individuals who did not qualify based on their 2020 income but have not yet filed their 2021 tax returns, there are still a limited number of planning strategies that could help them to qualify for forgiveness.

First, to the extent an individual is a business owner and still has the ability to make deductible contributions to a retirement plan for 2021 (e.g., a self-employed person contributing to their own SEP IRA), if those contributions, and the corresponding deductions, reduce AGI enough to get under the applicable threshold, such contributions should be carefully considered.

In addition, if the thresholds for single filers are also applied to married individuals who file separate returns, married couples with student debt should evaluate whether filing separate returns for 2021 makes sense, even if they normally file joint returns. If the debt forgiveness available to one spouse exceeds the additional tax burden (plus any other applicable costs, such as tax prep fees) created by filing separately, it could be a net win.

Types Of Loans Which Qualify For Forgiveness

In general, only Federal loans which were funded by June 30, 2022, are eligible for forgiveness, as announced by the Biden administration. However, existing debt (as of June 30, 2022) that was consolidated after the deadline is still eligible for relief.

Conversely, privately held student loans are generally not eligible for the same relief, regardless of the borrower’s level of income. This raises concerns for many borrowers with Federal Family Education Loans (FFELs), which are Federally backed loans originally funded by private companies. When these loans were originally issued, some were subsequently purchased by the Federal government, while others remained under the ownership of private companies. And while FFELs owned by the U.S. Department of Education will be eligible for forgiveness, it is not yet clear how loans held by private companies will be treated.

Initially, it was believed that all privately held debt, including those FFELs owned by private companies, would be ineligible for forgiveness (aligning with current guidance on forbearance and the 0% interest rate). However, the Department of Education has indicated a desire to extend forgiveness to those borrowers whose FFEL loans are owned by private companies, either directly or via loans that are consolidated to Direct Federal loans. Affected borrowers (and their advisors) are encouraged to pay close attention to these developments.

To the surprise of many, Federal loans taken out for graduate school are eligible for relief, as are Parent Plus Loans. Notably, maximum debt relief appears to relate to the borrower – not the student. Thus, parents with $30,000 of total Parent Plus loans spread out evenly over three children will ‘only’ be eligible for a maximum of $10,000 of forgiveness. By contrast, if a student’s parents had $10,000 of Parent Plus loans for their child’s education, and the child had an additional $20,000 and had received a Pell Grant, a maximum of $30,000 of debt related to that student’s education could be eliminated ($10,000 for the parents and $20,000 for the student).

Finally, it’s worth noting that current students with debt are eligible for relief as well. However, if the student is currently claimed as a dependent on their parents’ income tax return, their parents’ income will be used to determine eligibility.

Applying To Receive Loan Forgiveness

For some borrowers, the forgiveness process is going to be relatively easy. Notably, roughly 8 million student loan borrowers already have income information on file with the U.S. Department of Education (e.g., borrowers who are on an Income-Driven Repayment plan option) that will allow them to automatically receive forgiveness.

For others, the completion of a (purportedly) simple application will be necessary. The White House has directed the Department of Education to make the application available no later than the end of 2022, but the Department of Education has stated it intends to launch the application earlier than that, “in the coming weeks.”

Borrowers who want updates directly from the U.S. Department of Education can sign up to receive them by visiting https://studentaid.gov/debt-relief-announcement/.

Student Loan Payment Freeze Ending In December 2022

Borrowers of Federal student loans have benefitted from a temporary moratorium on student loan payments and interest since the early days of the COVID-19 pandemic, when former President Donald Trump issued an executive order in March 2020 first establishing the payment freeze. Subsequent extensions prolonged it for more than 2 ½ years, and though the freeze was set to expire at the end of August 2022, the Biden administration’s Student Loan Debt Relief Plan has added one final extension to the payment freeze, pushing the end date back 4 months from August 31 to December 31, 2022.

But, unlike previous instances when ‘final’ extensions were announced only to be re-extended further, the combination of this extension with the debt relief package makes it seem likely that this really will be the end of the line, and that Federal student loan borrowers will resume their payments in January 2023 after nearly three years of frozen payments and 0% interest.

Refunds Of Payments Made During The Temporary Payment Freeze Can Potentially Increase Forgiveness Amount

When the CARES Act passed in March 2020, it included a clause that allowed borrowers to ask for a refund of any payments made after March 13, 2020, when the payment freeze was first announced. This messaging is still clearly laid out on the U.S. Department of Education’s website, which states:

You can get a refund for any payment (including auto-debit payments) you make during the payment pause (beginning March 13, 2020). Contact your loan servicer to request that your payment be refunded.

As of this writing, this policy is still in effect and may create a potential planning opportunity for a portion of the roughly 1.5% of borrowers who continued to make voluntary payments during the moratorium. More specifically, borrowers whose voluntary payments made after March 2020, after the passage of the CARES Act, reduced their outstanding loan balance below their maximum forgiveness amount could request a refund of such payments to increase their outstanding debt. Which means that, to the extent the increased debt remains below their maximum forgiveness amount, there is a possibility that it may qualify for forgiveness!

Example 3: Josh is a single taxpayer with income in 2021 that was below his applicable $125,000 threshold. He had $26,000 of outstanding Federal student loans as of March 2020. Josh chose to keep paying down his debt to take advantage of the 0% interest.

As of August 2022, Josh’s outstanding balance is $2,500. Absent any further action on Josh’s part, he will be eligible to have his remaining $2,500 (the lesser of his loan balance and $10,000) of student loan debt forgiven by the Student Loan Debt Relief Plan.

Suppose, however, that Josh calls his loan servicer and asks for a refund of his payments made since March 2020. By doing so, he’ll receive a refund of the $26,000 – $2,500 = $23,500 in payments he made during the payment freeze, and his loan balance would increase back to $26,000 (the balance when the student loan payment freeze began).

If Josh had received a Pell Grant while he was an undergraduate, he might now be eligible for $20,000 of forgiveness. Which would mean that once his $20,000 of forgiveness is processed, his remaining loan balance due would only be $26,000 – $20,000 = $6,000. While this is $6,000 more debt than he would have been left with if he had simply continued paying his debt down to zero, by requesting the refund and qualifying for forgiveness, he will instead have $23,500 more in his bank account, making it a much better outcome!

To be clear, this strategy, if viable (more on this below), would only be beneficial to those who have made voluntary student loan payments since March 13, 2020, and who had income in 2020 or 2021 below their applicable threshold, and who currently have loan balances below their maximum forgiveness amount. While that group of taxpayers may be small, the potential windfall they could see makes this an important strategy for advisors to understand.

To implement this approach, individuals meeting the conditions described above should call their loan servicer to request a refund of those payments. Loan servicers will add any amounts paid down after March 13, 2020, back to the borrower’s outstanding loan balance, and the borrower will receive a refund in approximately 30-45 days.

Critically, for advisors discussing this approach with clients, it’s important to emphasize that it is not yet clear whether this strategy will work. More specifically, the Department of Education may limit forgiveness to the outstanding balance as of the date of the announcement. If they do take such an approach, subsequent increases in loan balances due to refunded payments could be ineligible for relief.

That being said, it can still be worthwhile for borrowers to request a refund of any post-freeze payments. The worst-case scenario would be that the borrower receives their refund and is considered ineligible for the maximum forgiveness because of their low loan balance at the time of announcement. But the borrower could simply take their refunded money and then pay it right back to their loans.

Of course, some borrowers may prefer to wait for more concrete guidance before taking action to avoid potentially wasting their time. This could be particularly true for borrowers who have a different loan servicer now than they did when they made their post-freeze loan payments, as it may be unclear which servicer is responsible for processing the refund.

In other cases, a borrower may have more than one loan servicer to deal with. In this case, the current servicer is the company that should be called to initiate the refund process. And, given the short timeline until forgiveness may start being processed, a borrower who is certain that they will ask for a refund should do so as soon as possible.

Impact Of The Temporary Public Service Loan Forgiveness (PSLF) Waiver

When the Public Service Loan Forgiveness (PSLF) program was initially implemented, it was created to forgive a borrower’s entire remaining Federal student loan balance for those who have spent 10 years working in a nonprofit or government job while making student loan payments. However, hundreds of thousands of qualified borrowers were rejected due to seemingly inconsequential oversights (e.g., being on the wrong repayment plan, having the wrong loan type, or making a payment that was just a dollar short), confusing PSLF requirements, and poor administration by service providers.

In response to these shortfalls, the U.S. Department of Education announced a plan to overhaul the PSLF program in October 2021, which provided a waiver temporarily expanding the types of loans and repayment plans eligible for forgiveness under PSLF, among other changes made. As part of this Public Service Loan Forgiveness (PSLF) Waiver, the Biden administration announced a 1-year window for Federal student loan borrowers to apply their repayment history toward the 10-year repayment period required by PSLF, whether or not any of their past payments were made to a previously ineligible loan type or through an ineligible repayment plan, or were disqualified earlier due to minor technicalities.

Specifically, the waiver allows borrowers who worked for eligible employers (Federal, state, and local governments and nonprofit organizations) during their loan repayment periods to get credit for their months of repayment when:

• Their loans were previously ineligible FFEL loans;
• They were on an ineligible repayment plan (i.e., not a 10-year Standard repayment plan or a longer Income-Driven Repayment (IDR) plan; and/or
• Their payment was late, short, or a lump-sum amount.

Additionally, the waiver allows borrowers who have consolidated multiple loans with overlapping repayment histories (e.g., a consolidation of loans received for both undergraduate and graduate degrees) to receive credit for the largest number of qualifying payments of the loans that were consolidated (though presumably only payments going back to October 1, 2007, when the PSLF program began, will be considered when making this determination).

While the waiver is slated to expire on October 31, 2022, the Biden administration’s Student Loan Debt Relief Plan will update the PSLF program by permanently implementing some of the changes introduced by the waiver (explained later). Notably, while the waiver has been open for 10 months, it has so far led to $10 billion dollars of loan forgiveness for 175,000 public servants. The National Bureau of Economic Research estimates that a total of 3.5 million borrowers could potentially benefit from the waiver and that at least $100 billion could be forgiven via the waiver if every eligible borrower were to complete the steps required. And with only two months left before the waiver expires, at which point many of the rules will revert to the previous requirements, borrowers must take steps immediately if they want to benefit from the waiver.

In addition to making some of these important changes introduced by the PSLF waiver permanent, the Biden administration’s relief plan also includes the designation of four PSLF “Days of Action”, dedicated to borrowers in specific sectors (government employees on August 24, educators on August 31, healthcare professionals and first responders on September 7, and private nonprofits on September 14), to raise awareness and encourage eligible borrowers to apply for forgiveness before the waiver’s October 31 due date.

Future Changes To PSLF Made By Debt Relief Plan

The Student Loan Debt Relief Plan also includes proposed future-looking changes to the PSLF program, most of which would permanently extend some of the provisions (though crucially, not all) included in the PSLF Waiver. The proposed changes include counting late, partial, or lump-sum student loan payments to qualify for PSLF. In the past, a payment that was one day late would be considered ineligible for PSLF. Similarly, lump-sum payments were previously only counted for one month, even if the amount paid was enough to cover more than one month’s required payment. The proposal would allow lump-sum payments to count for multiple months of qualifying credit towards PSLF.

The proposed changes would also credit the borrower under specific conditions when their loan is in deferment or forbearance. For example, if loans are placed into deferment while borrowers are enrolled in the Peace Corps or AmeriCorps, or if they are on National Guard Duty or active military service, the months when the loan was in deferment would now count towards PSLF even if no payments were made. Prior to the PSLF Waiver, those deferments would not count as qualifying months towards PSLF. This proposal looks to make that change permanent.

Although these provisions would be made permanent by the Biden administration’s debt relief proposal on a forward-looking basis, it’s important to note that in order to get credit for past payments previously considered ineligible – even for payments like late or partial payments that will be eligible going forward – borrowers must still apply for the PSLF Waiver prior to the October 31, 2022 deadline.

How Payment Refunds Made During The Freeze May Impact The PSLF Waiver

The policy permitting borrowers to request refunds of payments made after March 2020, when the loan payment freeze was implemented, has a potentially major impact on those who can benefit from the PSLF Waiver. Which means that those who can now qualify for PSLF through the waiver can potentially have loan balances they may have paid down during the loan freeze refunded to them, and forgiven through PSLF instead!

Example 4: Grant took out FFEL loans to pay for his undergraduate studies and opted into the Income-Based Repayment (IBR) plan when he graduated in 2010. He got a job working as a nurse in a public school and made consistent loan payments for the 10 years he believed he needed to qualify for PSLF.

In January 2020, Grant applied for PSLF only to learn that his FFEL loans disqualified him and that he had 0 payments that qualified for PSLF. At that point, frustrated by the program, Grant decided he would increase his payments to pay his debt down as quickly as possible, making payments of $700/month every month beginning in January 2020.

When the PSLF Waiver was announced in October 2021, though, Grant realized it was designed precisely for him. First, he called his loan servicer, FedLoan, and asked for a refund of the 20 (payments made from March 2020 to October 2021) × $700 (monthly payment amount) = $14,000 he had paid since the payment freeze began.

Once his refund was complete, he then consolidated his FFEL loans into a Direct Consolidation loan and certified his employment. Because he now meets the requirements to fully qualify for PSLF, and had already made the required number of qualifying payments, his remaining balance has been totally eliminated.

Even though the PSLF Waiver would still have permitted Grant’s full balance to be forgiven, had he not requested a refund of the payments that he made after the CARES Act loan payment freeze was announced, he would have been out that $14,000.

As the example above illustrates, it can make sense for borrowers previously on a path to paying their debt to $0, but who are now eligible to pursue PSLF (thanks to the PSLF Waiver), to ask for a refund of any loan payments they may have made since March 2020 when the loan payment freeze was announced.

Newly Proposed Income-Driven Repayment (IDR) Plan

The Student Loan Debt Relief Plan includes a newly proposed Income-Driven Repayment (IDR) plan, which would go into effect in July 2023. The (as-yet-to-be-officially-named) ‘New IDR’ plan would be significantly more generous than any of the other current IDR Plans.

While many questions remain about who will be eligible for the new IDR plan and what its final terms will be, one of the most significant policy changes, perhaps as significant as the actual $10,000–$20,000 of relief being offered to so many borrowers, is the interest subsidy that promises to cover the borrower’s unpaid monthly interest.

Interest Subsidies For Loans Under The New IDR Repayment Plan Will Help Borrowers Avoid Future Negative Amortization

Under the current IDR plans, borrowers face the detrimental phenomenon of negative amortization. This happens when accrued loan interest grows larger than the borrower’s required payment each month, which results in an increasing loan balance even when the borrower makes their required payments. However, the interest subsidy provision of the new IDR plan would potentially preclude any risk of negative amortization and interest capitalization.

According to the White House Fact sheet:

…the proposed rule would fully cover the borrower’s unpaid monthly interest, so that – unlike with current income-driven repayment plans – a borrower’s loan balance will not grow so long as they are making their required monthly payments…

By fully covering unpaid monthly interest, the new IDR repayment plan would remove many problems faced by borrowers that currently stem from interest capitalization. Currently, when a borrower moves from one repayment plan to another, enters or exits forbearance, or refinances to a private student loan, their unpaid interest capitalizes, which can result in the borrower owing interest on interest.

Example 5: Samir works as a public defender and has an Adjusted Gross Income of $60,000. When he went to law school, he borrowed $100,000 of unsubsidized Federal student debt at a 6% interest rate and opted into the REPAYE repayment plan.

Samir’s total annual loan payment was calculated to be $3,960 (based on his discretionary income). However, the total interest due on his loan was 6% × $100,000 = $6,000, which means that Samir had a total of $6,000 – $3,960 = $2,040 of unpaid interest in the first year.

Even though the REPAYE plan has the most generous interest subsidies of the existing IDR plans (providing a 50% interest subsidy), it still leaves 50% of the remaining interest unpaid. So while 50% of Samir’s $2,040 is subsidized, it brings his total unpaid interest down to $1,020.

Assuming no major life changes, Samir will be adding roughly $1,020 of interest to his loan balance every year. After 5 years, then, Samir will have paid roughly $3,960 (annual loan payment) × 5 = $19,800, but now owes $5,100 more dollars than he owed when repayment started!

At this point, Samir accidentally forgets to recertify his income on time, as is required annually, causing Samir’s account to be automatically moved into a different, less generous repayment plan. This is easily fixable, so Samir calls his loan servicer to fix it. A week later, he is put back into the REPAYE plan, but this triggers his outstanding loan interest to capitalize. Which means that his new principal balance is $100,000 (original balance) + $5,100 (outstanding interest capitalized)  = $105,100.

Of course, with a higher principal balance comes higher interest. Thus, Samir now accrues $105,000 × 6% = $6,300 of interest annually, which means that in year 6, his total interest would be $6,300 – $3,960 (total loan payment) = $2,340. And with the 50% interest subsidy, his unpaid interest after 6 years of paying would now be $2,340 ÷ 2 = $1,170.

Many of the problems that arise from unpaid interest are often made worse when a borrower’s circumstances are even less favorable than in Samir’s example above (e.g., they have a less generous repayment plan, larger loan balances, smaller incomes, etc.). Negative amortization is a common phenomenon for many borrowers; a study by the Congressional Budget Office in 2020 found that, for borrowers who enrolled in IDR plans in 2010, over 75% of the borrowers owed more in 2017 than they had originally borrowed!

While this may be a non-issue for those pursuing PSLF (as PSLF amounts are not considered taxable income), it is a huge problem for those who are not enrolled in PSLF and are on track for loan forgiveness as, per current law, the amounts forgiven under IDR plans will again be considered taxable income after 2025. And after 20–25 years of repayment, many borrowers find themselves owing taxes on an even greater amount of money than they initially borrowed.

The interest subsidy offered by the newly proposed IDR plan would eliminate the potential for negative amortization. From a purely financial lens, this would significantly lower the total repayment costs to borrowers, both in loan repayment and potential tax triggered by eventual forgiveness.

From a psychological standpoint, borrowers would no longer see their balances balloon over time. Even if they are on track for PSLF with an expectation that their total loan balance will be forgiven, it’s still hard for borrowers to see their balance increasing over time (despite payments being made on time every month) without worrying that they’re on the wrong path.

From a career standpoint, at least for borrowers pursuing PSLF, there may be fewer barriers to changing jobs, as the strategies to reduce payments are most beneficial when their job is eligible for PSLF. But without the risks of negative amortization and interest capitalization, there may be more flexibility for borrowers to change jobs with higher pay, instead of remaining in a job purely because their student loan balance had increased so much to the extent that the cost of switching into a non-PSLF-eligible job would be too great.

Other Provisions Of The New IDR Plan

Borrower Eligibility. It’s still unclear who will be eligible for the plan. With past rollouts of IDR plans, eligible borrowers have often been limited to those with loans after a certain date. For example, the “New IBR” plan is only available to new student loan borrowers after 7/1/2014. While we don’t know for certain, it seems likely that the newly proposed IDR plan will only be available to more recent borrowers instead of all student loan borrowers. For advisors, this will mean keeping an eye out for future guidance to determine which (if any) clients might be eligible to switch to the new IDR.

Loan Eligibility. It seems likely that only Direct loans will be eligible, and not Parent Plus loans. But this is purely speculation.

Determination of Monthly Payment Amounts. The newly proposed IDR plan is substantially more generous than other IDR plans, as borrowers will be required to pay only 5% of their discretionary income towards undergraduate loans, and 10% towards graduate loans. By contrast, other IDR plans require payments of 10%, 15%, or 20% of discretionary income.

For those with both undergraduate and graduate debt, payments will be calculated on a weighted average. For example, a borrower with $10,000 of undergraduate debt and $20,000 of graduate debt would have to pay 5%×($10,000 ÷ $30,000) + 10%×($20,000 ÷ $30,000) = 8.3% of discretionary income under this plan.

However, this plan also generously changes the calculation of “discretionary income.” In all prior IDR plans, discretionary income was calculated as a person’s total Adjusted Gross Income less 150% of their poverty line (as determined by their family size). In the newly proposed IDR plan, however, the calculation substantially decreases a person’s calculated discretionary income by increasing the percentage of the poverty line to 225%. Thus, under the new IDR plan, discretionary income is determined as follows:

New IDR Plan Discretionary Income = Adjusted Gross Income – 225% × poverty line

For example, three different borrowers would have their loan payment amounts calculated under different repayment plans as follows:

Forgiveness. This plan calls for the entire balance to be discharged after 20 years of making monthly payments on time. For those whose original balance is $12,000 or less, the entire balance will be discharged after only 10 years. The forgiven amounts will be considered taxable income.

Filing Status. We don’t know whether married borrowers will be able to file taxes separately so that the calculation of their monthly payments is based on only one spouse’s income. While this strategy is allowed on most IDR plans, it is not allowed on the REPAYE plan.

Payment Cap. We do not yet know if there will be a payment cap for the newly proposed IDR plan, or how this plan will work for married couples when both spouses carry Federal student loan debt. Currently, if both spouses are on an IDR plan, their required payments get prorated proportionally to each individual’s portion of the balance. This would become much more difficult when the required payment amount is different for graduate versus undergraduate debt.

Remaining Questions About The New IDR Plan

The proposed IDR plan leaves a lot of currently unanswered questions. A summary of those are:

• Who will be eligible for the plan?
• What loan types are eligible?
• Will any interest accrue while borrowers are in school and not yet in repayment status?
• How will married couples with both individuals on IDR plans be handled?
• Can married couples file taxes separately so that income from only the borrowing spouse is used to calculate monthly payments?

The administration will be publishing the newly proposed IDR plan in the Federal Register in the coming days, with the U.S. Department of Education hoping to finalize the rule by November 1, 2022. If finalized by then, it will go into effect on July 1, 2023.

Income-Driven Repayment (IDR) And Public Service Loan Forgiveness (PSLF) Account Adjustments

In addition to the Student Loan Debt Relief Plan announced in late August 2022, a separate announcement was made in April 2022 by the U.S. Department of Education about the Income-Driven Repayment (IDR) and Public Service Loan Forgiveness (PSLF) Program Account Adjustment. The proposed account adjustments are designed to address past problems with student-loan servicers incorrectly accounting for monthly payments made by borrowers, which can negatively impact progress towards loan forgiveness through IDR plans and PSLF.

Through the account adjustment changes, the U.S. Department of Education (ED) will conduct a one-time review of the past payment history of every student loan borrower on an IDR payment plan. Per the announcement:

• As part of this initiative, ED will conduct a one-time revision of IDR-qualifying payments for all William D. Ford Federal Direct Loan (Direct Loan) Program and federally managed Federal Family Education Loan (FFEL) Program loans.
• ED will conduct a one-time account adjustment to borrower accounts that will count time toward IDR forgiveness, including
• any months in which you had time in a repayment status, regardless of the payments made, loan type, or repayment plan;
• 12 or more months of consecutive forbearance or 36 or more months of cumulative forbearance toward IDR and PSLF forgiveness;
• months spent in deferment (with the exception of in-school deferment) prior to 2013; and
• any time in repayment prior to consolidation on consolidated loans.
• Any borrower with loans that have accumulated time in repayment of at least 20 or 25 years will see automatic forgiveness, even if you are not currently on an IDR plan.
• If you have commercially held FFEL loans, you can only benefit from the IDR account adjustment if you consolidate before we complete implementation of these changes, which is estimated to be no sooner than January 1, 2023.
• If you have made qualifying payments that exceed forgiveness thresholds (20 or 25 years), you will receive a refund for your overpayment.

Importantly, these adjustments can have a significant and immediate impact on PSLF applicants, especially for those who spent long periods of time with their loans in forbearance or deferment.

Example 6: Janet graduated from her social work program in 2014 with $90,000 of Federal student loan debt. In the same year she graduated, she began working as a social worker at the Veterans Administration (VA).

Janet struggled to make payments during the first 48 months out of school and spent the bulk of that time (43 months) with her loans in forbearance. She only made 5 payments on time in those 4 years.

In 2018, she got her finances sorted out and enrolled in the Revised Pay As You Earn (REPAYE) plan. Since then, she has earned a total of 50 monthly-payment credits toward loan forgiveness through PSLF.

Under the terms of their Income-Driven Repayment And Public Service Loan Forgiveness Program Account Adjustment, the U.S. Department of Education is expected to credit Janet with 43 additional months of credit towards PSLF forgiveness that she was previously ineligible for due to being in forbearance.

Janet needs to file her employment certification form for the time she was in forbearance and, once filed, the department should update her records to give her credit.

This brings her PSLF qualifying payments toward forgiveness up from 50 to 93, meaning Janet is now just 27 months away from forgiveness.

Since the announcement was made in April, no further FAQs have been released, so exactly how this program will be implemented remains unclear. However, the announcement notes that “ED will begin work on implementing these changes immediately, but borrowers will not see the effect in their accounts until fall of 2022.” Which means that borrowers should be reviewing their student loan accounts this fall to ensure they are properly credited for any months that should be eligible under this one-time adjustment.

Action Steps To Access The PSLF Waiver And IDR Account Adjustments

Borrowers who work in public service and have FFEL loans can benefit from consolidating their loans as soon as possible. It is also important to file employment certification forms for any months they worked at a qualifying job starting in October 2007. In addition to being required for PSLF, the consolidation is also necessary to access the $10-$20k forgiveness announced on August 24, 2022. So, even if a borrower does not end out qualifying for PSLF, there is no practical downside to consolidation right now and two different enormous possible upsides.

Borrowers who were previously on the wrong repayment plan to be eligible for PSLF should file their employment certification forms for all months they were previously ineligible. They can then enroll in a PSLF-qualifying repayment plan for when payments restart in January 2023. Going forward, the requirement will once again be that borrowers must be on a qualifying repayment plan to be eligible for PSLF. Qualifying repayment plans include any of the IDR Plans (Income Contingent Repayment, Income Based Repayment, Pay As You Earn, or Revised Pay As You Earn), as well as the 10-Year Standard repayment plan.

Another major change to the student loan landscape is different loan servicers. Previously, FedLoan was the servicer responsible for every borrower enrolled in PSLF. However, FedLoan will be exiting the student loan servicing business by the end of 2022. All borrowers who are pursuing PSLF will now have their loans managed by a different student loan servicer, MOHELA. FedLoan has already begun to send its student loan accounts to MOHELA and will continue this transfer in the coming months.

Once their loans have been transferred to MOHELA, borrowers should confirm that their monthly payment counts are accurate. As while the U.S. Department of Education does have records of historical payments, past servicer transitions have led to errors and inaccuracies. Additionally, those who are eligible for additional credits through IDR Account Adjustments should see an updated count of eligible payments once the manual review of accounts has been completed sometime this fall.

What Can Financial Advisors Do Right Now To Help Clients Eligible For Relief Maximize Their Benefits?

For advisors who want to help their clients with student loans, conducting an audit to identify all clients with outstanding Federal student loan debt can be a good way to start. The first decision regarding student loan planning typically involves determining if the borrower intends to pay their debt to $0 or is working towards some type of forgiveness, either via the 10-year PSLF plan or through a 20–25-year IDR plan. The next step would be to determine if clients are still on the same repayment path as the one they were on prior to the payment freeze and if their current plan is still appropriate for them.

For example, if a client works at a nonprofit and has FFEL loans, their prior strategy may have been to pay the debt down to $0. But, with the PSLF Waiver and the 34 months (i.e., from March 2020 to December 2022) of PSLF credits borrowers are potentially eligible for throughout the payment freeze, PSLF may be a far better option now.

Conversely, some borrowers may have been on a path to PSLF but are now eligible to have either $10,000 or $20,000 of their loan balance canceled from the new Student Loan Debt Relief Plan. Depending on the new loan balance after the cancelation, their total payoff costs could be lower if they were to just pay their debt down to $0 than they are to get to their 120 required payments for PSLF.

Reacclimating Borrowers To Re-Establish Timely Loan Payments

The likely resumption of student Federal loan payments at the beginning of 2023 means that one of the key conversations for advisors to have with clients involves developing a strategy for when their payments (finally) do resume again.

The first and most obvious consideration is how resuming student loan payments will impact the borrower’s budget. Advisors can help clients determine how much they can expect their payments to be when they resume, and ensure that the client makes any adjustments to their spending needed to keep a sustainable cashflow when that time comes.

Notably, this may or may not involve the borrower’s payments returning to the same amount that they were paying pre-pandemic. According to the studentaid.gov website:

If you’re on a traditional repayment plan, such as a Standard, Graduated, or Extended Repayment Plan, then your loan servicer may recalculate your payment amount when the payment pause ends. Your loan servicer would base your new payment amount on:

1. your current balance of principal and interest and
2. your remaining repayment period.

If you’re on an IDR plan, your payment amount will return to what it was before your payments were paused (unless you’ve recertified or switched plans since the payment pause began).

In other words, payments for non-IDR plans might be recalculated based on the current loan balance and the remaining time left on the loan, while for those on IDR plans, the new payment will be the same as the old pre-pandemic payment – so long as the borrower hasn’t recertified their income since before the payment freeze began.

And although the annual income recertification requirement will also begin again in 2023, the earliest that any borrower will need to recertify their income will be March 2023 (and some won’t be required to do so until January or February 2024!), so most IDR borrowers’ payments will resume at the same level as they were in March 2020.

Speaking of income recertification, another part of the client conversation might involve planning for when the client will recertify their income when the new requirements kick in. When payments resume in January 2023, many borrowers on IDR plans will be making payments based on their 2018 income, which was the last year for which tax information would have been available when the payment freeze began in March 2020. Since income recertification takes into account income from the borrower’s most recent tax year, borrowers whose income increased between 2018 and 2021 would likely be better off delaying recertification for as long as possible to maximize the number of payments at the lower pre-pandemic level before recertification causes them to increase – though if for some reason there was a decrease in income since 2018, it would conversely make sense to recertify before resuming payments in January 2023.

Finally, preparing clients for the resumption of student loan payments might require a refresher on how the loans are paid. Many student loans may have changed servicers since the last time payments were made (for example, FedLoan has stopped servicing loans and has begun transferring loans to MOHELA and other service providers, and borrowers originally serviced by Navient have been transferred to Aidvantage), so borrowers first need to be certain about who they are repaying by checking their studentaid.gov account before they start making payments. They also might need to create new login accounts, update or change bank account links, and update autopay features to ensure their payments are made on time when they’re due in January.

Of course, if the borrower’s loan balance is entirely wiped out by the forgiveness program, or if they have become eligible for forgiveness through PSLF or IDR during the payment freeze period, debt forgiveness might have no direct impact on their monthly budget since there will be no payments to resume – although other factors, like the effect of loan forgiveness on the borrower’s credit score, might have an additional indirect effect. But for everyone else, a reality check on what life looks like with the return of student loan payments will be a valuable way to transition back into making payments in 2023.

Calendar Of 2022–2023 Student Loan Dates For Financial Advisors

Below is a summary of important dates relating to student loans for advisors to be aware of:

Though many Federal student loan borrowers may have gotten used to the idea of not making payments since the beginning of the payment freeze in March 2020 – and plenty has happened since then, between the COVID pandemic and the rollercoaster of economic uncertainty that followed, that has proven to be more important in the big picture – their loan burdens have not gone anywhere in the intervening months. And for many, neither has the accompanying nagging feeling of having debt, even if that debt was in the service of creating opportunities for the borrower that would have never existed without access to higher education.

The Biden administration’s Student Loan Debt Relief Plan, therefore, has the power to be life-changing for many individuals by wiping away a significant amount (if not all) of the debt burden that, for many borrowers, has been hanging around in stasis for over two years (and for many borrowers, had existed for years, if not decades, before that). For other borrowers, it represents an opportunity to begin making long-awaited progress on that debt – either through lower, restructured debt payments calculated by the new Income-Driven Repayment (IDR) plan or, for those now eligible, through future debt relief offered by the Public Service Loan Forgiveness (PSLF) program.

For financial advisors, this is an incredible opportunity to connect with clients on a topic of deep significance and to provide valuable guidance on the best path forward. Though the proposed plan’s benefits might not be equal across all borrowers, it’s a rare policy announcement that, for almost everyone, is neutral at worst and extremely positive at best. Advisors can take this chance to touch base with clients and celebrate with them – and then get down to planning!