How Do Student Loans Calculate Discretionary Income?

Discretionary income refers to the money you have leftover after paying for necessary expenses like rent/mortgage, utilities, and groceries. But it also refers to the money you have left to pay towards your federal student loan debt. In this post, I’ll explain how discretionary income impacts the amount you pay towards federal loans each month.

In general, discretionary income is the amount of income you have left from your take-home pay for spending, investing, or saving after paying taxes and paying for personal necessities, such as food, shelter, and clothing. It’s money that’s used to cover both essential and nonessential or discretionary expenses.

Discretionary income is the income remaining after covering essential costs such as taxes, everyday expenses, and household bills. In the context of federal student loans, this amount is crucial for determining your monthly payments under income-driven repayment (IDR) plans.

But discretionary income in the student loan setting isn’t just what’s left over. It’s calculated using a specific formula by the U.S. Department of Education.

This formula considers the difference between your adjusted gross income and either 100% or 150% of the poverty guideline for your family size and state of residence. Plans like IBR, and PAYE generally use 150% of the poverty guidelines, while the ICR Plan can also use 100%. Biden’s new student loan repayment plan uses 225%.

Related: How Income-Based Repayment is Calculated

Discretionary income is not the same as disposable income. Discretionary income is the amount of money left after paying necessary expenses. You use it to pay for vacations, trips to the movies, date nights, etc. Disposable income is the net income money a household or individual has left to invest, save, or spend after income taxes have been deducted from your paycheck.

The discretionary income formula is (AGI less 1.5 or 1.0 of family size) divided by 12. Here’s how to use that formula:

1. Locate your AGI. AGI is your adjusted gross income, which is your gross income after eligible deductions. It is not your annual income. Your AGI is listed on line 11 of the 2019 and 2020 federal income tax returns.

2. Count your family size. Your family size includes any child you provide more than 50% for no matter where they live. It also consists of any adult that lives with you more than 50% of the year and that you provide more than 50% of their support.

3. Check the poverty line. The Department of Health and Human Services (HHS) releases a federal poverty guideline annually for the 48 contiguous states and the District of Columbia, Alaska, and Hawaii. The last two states have a higher cost of living, so the HHS generates a different poverty line for those states. The poverty guideline measures the federal poverty level for your family size.

4. Multiply the poverty line by 150%. The IBR, PAYE, and REPAYE student loan repayment plans calculate your monthly payment amounts by using 150% of the poverty line for your family size.

5. Calculate your discretionary income. Those same three plans define discretionary income as your adjusted gross income minus 150% of the poverty line of your family size.

Lenders of private student loans don’t offer borrowers payments based on their income. If you’re struggling to make your payment each month, look into refinancing for a lower interest rate or longer repayment term. To refinance, you’ll need a good credit score and stable income.

Discretionary Income Example

Kate is single. She has no children and lives alone. She lives in California. She’s repaying her loans under the REPAYE Plan. The adjusted gross income on her 2020 federal tax return is $50 thousand. The federal poverty line for a family size of one in California is $12,880. Multiplied by 150%, that amount becomes $19,320. The final step is for Kate to subtract $19,320 from her AGI, $50 thousand. Kate’s discretionary income for her federal student loan debt is $31,680.

The federal government offers borrowers four payment plans based on their income:

• Income-Based Repayment Plan

• Income-Contingent Repayment Plan

• Pay As You Earn Plan

• Revised Pay As You Earn Plan

Each of these federal student loan repayment plans uses a different formula to calculate your monthly payment, typically either 10 or 15% of your discretionary income. These plans also offer loan forgiveness at the end of the repayment term.

Let’s return to the example from above.

Kate’s adjusted gross income is $31,680. She’s in the REPAYE Plan, which uses 10% of her discretionary income to calculate her monthly payment. Ten percent of Kate’s discretionary income is $3,168, divided by 12, which gives Kate a $264 payment each month.

Discretionary Income Calculator

‍While borrowers can calculate their discretionary income and monthly payment by hand, they don’t have to. The Federal Student Aid website, studentaid.gov, allows federal student loan borrowers to estimate their monthly payments under the various repayment plans using the Loan Simulator.

Discretionary income changes as your family size and income increases or decreases, or you move to a different state. Each year, you’ll need to submit the annual recertification to your loan servicer to remain in an IDR plan. The annual recertification asks you to confirm your family size, income, and state of residence when you’re signing the Income-Driven Repayment Plan Request form. If you don’t complete the recertification on time, your payments may increase to what they would be under the Standard Repayment Plan.

Changes in your family size, income (or spouse’s income), or residence can affect your monthly payment year to year.

Learn More: Marriage and Student Loan Repayment

Your family size and the federal poverty level aren’t always fair indicators of your necessary expenses. The IDR Plans don’t include your debt from credit cards, car payments, medical bills, child support, and private student loan debt when calculating your discretionary income.

Related: Does Having a Child Reduce Student Loan Payments?

As a result of those expenses, some federal student loan borrowers won’t get an affordable monthly payment under the IBR Plan. Instead, they’ll need to repay their loans under the Graduated or Extended Repayment Plan. And if you can’t afford those payments, ask for a deferment or forbearance.

Under an IDR Plan, your monthly payment is based on, among other things, your AGI. You can lower your AGI by increasing your contributions to retirement accounts like a 401(k) or traditional IRA.

Of course, not all borrowers have money left after paying their essential expenses to contribute more towards retirement. But those who can do so can lower their monthly student loan payment.