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With a bit of strategy, federal student loan borrowers can lower their monthly bills on the U.S. Department of Education’s new repayment plan, coming July 1.
Under the Repayment Assistance Plan, or RAP, borrowers pay a higher percentage of their income as their earnings grow. That means that finding ways to lower your pretax income by even a small amount can reduce your monthly student loan payments, said Landon Warmund, a certified financial planner and certified student loan professional at Reliant Financial Services in Kansas City, Missouri.
“There’s definitely some unique opportunities with it,” said Warmund, a member of CNBC’s Financial Advisor Council.
Figuring out how to reduce your monthly loan bill under RAP may be especially important for the millions of borrowers now forced to leave the Biden-era Saving on a Valuable Education, or SAVE, plan. A federal appeals court ended SAVE, the most affordable repayment plan to date, earlier this year.
Student loan borrowers need to exit SAVE within roughly 90 days of July 1, and many will see higher required payments under other plans.
“Borrowers can look to avoid these payment jumps by exploring what pre-tax benefits they have available to them at work to reduce their taxable income, which keeps them under key income numbers,” Warmund said.
Here’s how borrowers can try to reduce their payments under RAP.
How RAP calculates your monthly bill
Under RAP, monthly payments will typically range from 1% to 10% of your earnings; the more you make, the bigger your required payment. There will be a minimum monthly payment of $10 for all borrowers.
Current income-driven repayment plans, or IDRs, offer certain very low-income borrowers a $0 monthly payment.
RAP also doesn’t shield a portion of a borrower’s income for necessary expenses in its bill calculation, as other IDR plans do; instead, it determines the payment based on adjusted gross income. AGI is your total earnings before taxes, minus certain deductions.
For those who enroll in RAP, “even a single dollar difference in AGI could lead to a several-hundred-dollar impact in regard to total student loan payments over a year,” Warmund said.
For example, due to RAP’s formula, a student loan borrower with an AGI of $59,999 a year could pay about $50 a month, or $600 a year, less than a borrower who has a $60,000 AGI, he said.
How to reduce your adjusted gross income
There are several ways that borrowers may be able to reduce their AGI, and therefore lower their monthly RAP bill, said Carolina Rodriguez, director of the Education Debt Consumer Assistance Program in New York, a nonprofit that assists borrowers.
Directing a portion of your paycheck to your workplace 401(k) retirement plan or a traditional IRA — or increasing your contributions to these accounts — is one method, Rodriguez said. Keep in mind: To lower your AGI, those contributions need to be pretax or deductible, so money put into a Roth IRA or Roth 401(k) wouldn’t help here.
If a single student loan borrower contributed an additional $1,001 in a year to a pretax retirement account, lowering their AGI to $69,999 from $71,000, their monthly payment on RAP would fall to $350 from $414, Warmund said.
The RAP plan does have a lot of nice benefits if you plan accordingly.
Landon Warmund
Certified financial planner
Making pretax contributions to a health savings account, or HSA, or a flexible spending account, or FSA, are additional options to bring down your taxable wages, Rodriguez said. Companies can offer several kinds of FSAs, including for qualifying healthcare, dependent care and commuting expenses.
Meanwhile, if you’re self-employed, claiming legitimate business expenses and deductions on your Schedule C can have the same outcome, Rodriguez said.
“This can include ordinary and necessary business costs, retirement contributions and health insurance deductions,” she said.
Other “above-the-line” deductions can also lower your AGI, including the break on student loan interest.
Per-dependent savings of $50
Under the RAP plan, federal student loan borrowers can also get their monthly bill reduced by $50 for every dependent they claim, Rodriguez said. Dependents are often minor children, but can also include siblings or other relatives in specific cases, according to IRS guidelines.
Those savings should be automatic and tied to your tax filing.
“It’s based on the number of dependents the borrower claims on their federal tax return,” she said.
You may still pay more over time
Even if you’re able to lower your monthly payment under RAP, you may end up paying more than you would on other plans over the life of the loan, Rodriguez said. That’s because RAP leads to student loan forgiveness only after 30 years, compared with the typical 20- or 25-year timeline on other IDR plans.
As a result, some borrowers may want to compare their monthly bill and total payment amount on RAP to other repayment plans. However, RAP will be the only IDR plan available to student loan borrowers who take out a loan after July 1.
Borrowers with existing federal student loans may maintain access to some current IDR plans, including the Income-Based Repayment plan, or IBR. IBR borrowers are eligible for debt forgiveness after 20 years or 25 years, depending on the age of their loans.
While the Income-Contingent Repayment plan, or ICR, and PAYE, or the Pay As You Earn plan, will also remain available to current borrowers until mid-2028, neither program now results in debt forgiveness. The only reason you’d want to be in either plan, then, is if it brings you the lowest monthly payment, Rodriguez said.
If that’s the case, you can remain in ICR or PAYE until the plans expire on July 1, 2028. Afterward, if you switch into IBR or RAP, you’re entitled to credit toward forgiveness for your previous payments.
“If RAP will be your lowest option, wait for it to become available,” Rodriguez said. “But be mindful of the plan’s implications.”
