SAVE Plan Tax Bomb: What Borrowers Need to Know

If you’re one of the 7.5 million borrowers enrolled in the Save on a Valuable Education (SAVE) Plan, you’re probably enjoying benefits like lower monthly payments, interest subsidies, and shorter forgiveness timelines. That’s great news for your budget! But while you’re counting down the days until your loans are forgiven, it’s important to be aware of one potential drawback: the SAVE Plan’ tax bomb.’

What’s the SAVE Plan tax bomb, you ask? Under current federal tax law, any student loan debt forgiven after December 31, 2025, will be considered taxable income. That means you might face a significant one-time tax bill when your remaining balance is forgiven after 10 to 25 years under SAVE.

Don’t panic just yet, though.

In this article, we’ll dive into the details of the SAVE Plan tax bomb, including current federal tax laws, how to calculate your potential tax liability, and strategies to reduce or avoid this financial pitfall. By understanding the tax implications of loan forgiveness and taking proactive steps, you’ll be better prepared for a brighter financial future. Let’s get started!

Key takeaways:

• The SAVE Plan tax bomb is a potential tax liability borrowers may face when their remaining student loan balance is forgiven, as forgiven debt after December 31, 2025, will be considered taxable income.

• To reduce the effect of the tax bomb, borrowers can explore tax-exempt loan forgiveness programs, such as Public Service Loan Forgiveness, and start saving early to prepare for the potential tax bill.

• Borrowers should stay informed about federal and state tax laws changes and consult student loan experts to develop a personalized strategy for navigating the SAVE Plan tax bomb and meeting their financial goals.

The SAVE plan tax bomb is a potential financial consequence you may face when your remaining student loan balance is forgiven after completing the required repayment period. While loan forgiveness is a significant benefit, you must understand its potential tax implications.

Under current federal tax laws, student loan debt forgiven after December 31, 2025, is treated as taxable income for private and federal student loan borrowers. The forgiven amount is added to your taxable income for the year the loans are forgiven, potentially resulting in a substantial one-time tax bill.

For example, if you have $50,000 in student loans forgiven in 2030 and your annual income is $70,000, the forgiven debt would bring your total taxable income to $120,000. This increase could push you into a higher tax bracket, leading to a larger tax liability.

The potential financial impact of the tax bomb varies based on factors such as your income, tax filing status, and the amount of debt forgiven. You may face a more significant tax bill if you’re in a higher tax bracket or have a larger loan balance.

Related: Is The Save Plan Worth It?

Current federal tax laws temporarily shake up the SAVE plan tax bomb. As of now, student loan debt forgiven after December 31, 2025, will be considered taxable income by the federal government, meaning you may face a tax liability.

But the American Rescue Plan Act, signed into law in March 2021, offers temporary tax relief for federal loan forgiveness through December 31, 2025. If you receive debt forgiveness from the U.S. Department of Education under any of President Biden’s programs during this period, you won’t have to pay federal income taxes on the remaining balance that’s forgiven.

This temporary relief is set to expire at the end of 2025, however.

Unless Congress tries to extend or make the exemption permanent, you will be subject to the tax bomb if your loans are forgiven after that date.

While the American Rescue Plan Act provides federal tax relief for loan forgiveness, individual states may still tax forgiven student loan debt as income. For example, Minnesota does not tax amounts forgiven under income-driven repayment plans, while other states like New York and California may tax forgiven student loan debt. Check your state’s specific tax laws to understand your potential liability.

Related: SAVE Plan Income Limits

To plan for the potential tax consequences of student loan forgiveness under the SAVE plan, you need to understand how to estimate your tax liability. The taxes you’ll owe on forgiven debt depends on your income, tax filing status, and the amount of debt forgiven.

Your income tax bracket influences your tax liability. As of 2024, there are seven federal income tax brackets, ranging from 10% to 37%. The higher your taxable income, the higher your tax bracket, and consequently, the higher the percentage of forgiven debt you’ll owe in taxes.

Here’s how to estimate your potential tax liability:

1. Add the amount of forgiven debt to your projected annual income for the year of forgiveness.

2. Determine your tax bracket based on this taxable income and filing status.

3. Multiply the forgiven debt by your tax bracket percentage.

For example, if you’re a single filer with an annual income of $50,000 and $40,000 in student loans forgiven in 2028, the forgiven debt would be added to your taxable income, bringing it to $90,000. Assuming tax brackets like 2023 would put you in the 22% tax bracket, resulting in about $8,800 in taxes owed on the forgiven debt.

Can you rely on these calculations indefinitely? Not exactly. These calculations are based on current tax laws and brackets, which may change. Individual financial circumstances can also affect the ultimate tax liability.

If you’re enrolled in the SAVE plan and working towards Public Service Loan Forgiveness (PSLF), you may wonder how these programs affect your tax liability. Fortunately, PSLF offers tax-free loan forgiveness, even if you’re on the SAVE plan. But there are important details to remember to ensure you qualify for this benefit and avoid the tax bomb.

PSLF offers tax-free loan forgiveness if you work full-time for a government or non-profit organization and make 120 qualifying monthly payments under an income-driven repayment plan like SAVE. If you meet all PSLF requirements, your remaining loan balance is forgiven, and you will face no tax liability, no matter when the forgiveness occurs.

This means that if you’re eligible for PSLF and have your loans forgiven under this program, you won’t be subject to the tax bomb, even if the forgiveness occurs after the temporary tax relief ends on December 31, 2025. To qualify for tax-free forgiveness, you must meet all PSLF requirements.

If you’re pursuing PSLF but don’t meet the requirements by the time your loans are forgiven under SAVE, you may still be subject to the tax bomb. Ensure you’re meeting all the requirements for PSLF, such as working for a qualifying employer and making the 120 qualifying payments, to receive tax-free loan forgiveness. If you’re unsure about your eligibility or progress toward PSLF, contact your loan servicer or the Federal Student Aid office for guidance.

Is loan forgiveness under PSLF tax-free in all states? Not necessarily. Some states may have their own tax laws that differ from federal regulations. Research your state’s specific tax laws to understand the potential state-level tax implications of loan forgiveness under PSLF and the SAVE plan.

Related: Does the SAVE Plan Qualify for PSLF?

While the tax bomb can be a significant financial burden, there are several strategies to help minimize or avoid this tax liability:

1. File for an insolvency claim: If your total liabilities exceed your total assets when the debt is forgiven, you may exclude some or all of the forgiven debt from your taxable income by filing Form 982 with your federal tax return.

2. Explore tax-exempt loan forgiveness programs: Some loan forgiveness programs, such as Public Service Loan Forgiveness (PSLF) and Total and Permanent Disability (TPD) discharge, offer tax-exempt forgiveness. Research these programs to determine whether you qualify for tax-exempt forgiveness based on your situation.

3. Save and plan early: If you’re enrolled in the SAVE plan, consider setting aside money each month in a dedicated savings account to pay the potential tax bill when your loans are forgiven. Break down the estimated tax liability into manageable monthly savings goals to be better prepared for the financial impact of the tax bomb.

4. Stay informed about changes to tax laws: Stay up-to-date on any changes to federal or state tax laws that could affect the tax treatment of forgiven student loan debt.

The best strategy for reducing or avoiding the tax bomb depends on your financial situation and eligibility for various loan forgiveness programs.

As you prepare for the potential tax liability associated with loan forgiveness under the SAVE plan, don’t neglect your other financial priorities. Balancing multiple goals is key to building a strong financial foundation and achieving long-term success. Focus on:

1. Saving for retirement and the tax bomb: Consistently contribute to retirement accounts, such as 401(k)s or IRAs, to build a solid foundation for your future. At the same time, consider setting aside money specifically for the potential tax bomb. For example, if you can afford to save an extra $100 per month, assign $50 towards your retirement accounts and $50 towards a dedicated savings account for the tax bomb. Adjust these amounts based on your financial situation and goals.

2. Building an emergency fund: Aim to have a sufficient emergency fund (typically three to six months’ worth of living expenses) to provide a critical safety net in case of unexpected expenses or income disruptions.

3. Funding other financial goals: Consider other priorities, such as buying a home, starting a business, or saving for your children’s education. Develop a plan that balances these goals with preparing for the tax bomb.

To create a comprehensive financial plan that accounts for the tax bomb and other goals:

• Assess your current financial situation

• Set clear, measurable financial goals with specific timelines

• Focus on goals based on your values and long-term objectives

• Develop a budget that assigns resources toward each goal

• Track progress regularly and adjust the plan as needed

The SAVE Plan tax bomb is a complex issue that requires careful planning and understanding. While the strategies outlined in this article can help you reduce or avoid the potential tax liability, everyone’s financial situation is unique.

For personalized guidance tailored to your specific needs, book a call with our team of student loan experts. We’ll work with you one-on-one to develop a customized strategy that helps you navigate the SAVE Plan tax bomb, reduce your tax liability, and achieve your long-term financial goals. Don’t let the tax bomb derail your future – act today and schedule your consultation.