How AGI Affects Student Loans [Tip: Lower AGI, Lower Payments]

If you’re wanting to lower your monthly payment on your student loans, your ability to do so comes down to one of two things:

1. lowering your adjusted gross income; or

2. Increasing your family size.

In another post, we’ll go over family size. For now, let’s keep our focus on AGI.

But first, let’s tackle the big question many people have with AGI and student loans…

Your adjusted gross income is your total gross income minus certain deductions. The income driven repayment plans will use your AGI to calculate your monthly payment.

There’s a direct relationship between your AGI and the monthly payment due on your federal student loans. The lower your AGI, the lower your monthly payment. Likewise, the higher your AGI, the higher your monthly payment.

Because there’s a direct relationship between your AGI and your student loans, the easiest way to lower your monthly payment is to lower your AGI. (We’ll go over 7 ways to lower your AGI later.)

As you know, the Department of Education offers a bunch of repayment plans based on your income.

For the most part, the plans work the same: they use your student loan balance, your AGI, your family size, and state of residence to calculate your discretionary income.

Let’s talk about discretionary income real quick. Basically, your discretionary income is the difference between your AGI, the poverty guidelines for your family size, and a multiplier of either 1.5 (REPAYE, PAYE, and IBR) or 1 (ICR).

Here’s what I mean:

Let’s say your AGI is $50 thousand, your family size is 4, you live in Texas, and you want to use the REPAYE plan. The poverty guidelines for a family size of 4 is $25,100.

So you take that number and multiply it by 1.5. That gives you $37,650.

Now that we have that number, we need to subtract it from your AGI ($50,000 less $37,650). That leaves a balance of $12,350. This is your discretionary income.

From there, each plan uses your discretionary income to calculate your monthly payment.

Here’s how that works:

1. REPAYE, PAYE, and New IBR. Each plan takes your discretionary income, multiplies it by 10%, and then divides that number by 12 to get your monthly payment. You’ll have the lowest monthly payment under these plans.

2. IBR. The income based repayment plan uses your multiplies your discretionary income by 15% and then divides that number by 12 to get your monthly payment. Unless you’re married, you likely should choose the REPAYE or PAYE plans over the IBR plan.

3. ICR. The income contingent repayment plan is different than the other plans in 2 ways. First, it uses a multiplier of 1 when calculating your discretionary income. Second, it multiplies your discretionary income by 20%. Both of those combine to give you the highest monthly payment of all the IDR plans. Choose this plan only if you have Parent Plus Loans.

Protip. You can avoid having to do the math yourself by using the Department of Education’s Repayment Estimator. Once you log in with your FSA ID, that tool will import your student loan information and your AGI so that it can calculate your estimated monthly payments under the income driven repayment plans.

With federal student loans, your marriage affects your AGI because at tax season you have to decide:

Should we file taxes jointly or separately for student loans?

Answer: It depends.

When it comes to student loans, the decision of whether to file taxes jointly or separately is complicated. Questions I ask clients include:

• How much do you and your spouse earn?

• Do you both have federal student loans?

• Are your federal loans Direct Loans, FFEL Loans, or a combination of the two?

The answers to those questions help guide my advice on whether to file taxes jointly or separately, whether student loan consolidation makes sense, and which repayment plan is the best repayment plan.

Pro-tip. For many married borrowers where both spouses work and have federal student loans, the best repayment plan is likely the REPAYE plan. In cases where only one spouse works, filing separately might make sense. That way either spouse can use the PAYE or IBR plan and have only their AGI counted.

Further reading. An excellent review of student loans, marriage, and taxes was done by Prof. Victoria Haneman in The Collision of Student Loan Debt and Joint Marital Taxation.

You can find last year’s adjusted gross income by looking at line 37 on IRS Form 1040.

If you filed a 1040EZ, your AGI is on line 4.

And if you filed a 1040A, your AGI is on line 21.

You can calculate your AGI in 3 steps:

1. Get your total income by totaling lines 7-22 on Form 1040.

2. Next, total deductions by adding lines 23-35.

3. Finally, subtract line 22 by line 36. This is your adjusted gross income.

Your AGI is your greatest tool in lowering your monthly payment. There are several deductions you can take and strategies you can use to lower your AGI and thereby lower your federal student loans payment.

Speaking with a financial planner, a CPA, and, later, a student loan lawyer, can help you decide the best option for you by giving you real numbers.

That way you don’t have to guess about whether to file jointly or separately, or whether you should contribute to a retirement vehicle, or pay off your loans aggressively.