According to the National Association of Colleges and Employers' (NACE) Winter 2018 Salary Survey, 2018 graduates of bachelor’s degree programs are expected to earn $51,448 to $66,521 annually. Considering that the average student loan debt is $26,830, most students will use a portion of their starting salary to repay student loan debt.
For recent graduates who don’t yet have the experience to command higher earnings, income-driven repayment (IDR) plans offer some relief. With an income-driven repayment plan, students pay 10-20% of their “discretionary income” toward their student loans.
Discretionary income is the amount you have left over after paying for essentials, such as rent, food, utilities, car, and insurance payments. Imagine that your monthly salary is $4,000. If your rent is $1,500 per month, food costs are at about $500 each month, and your other bills total $500 monthly, your discretionary income amounts to about $1,500.
The US Department of Education calculates “discretionary income” a bit differently, using the poverty line as a guideline. The four IDR plans define discretionary income as follows:
Income-Based Repayment (IBR), Pay As You Earn (PAYE), and Revised Pay As You Earn (RPAYE) plans: 150% of the poverty guideline for your state and family size, subtracted from your yearly income.
Income Contingent Repayment Plan: the poverty guideline amount deducted from your annual income.
For example, if you are in a single-person household with an annual salary of $50,000, subtract $18,210 from your annual salary to determine your discretionary income — $31,790. Divide $31,790 by 12 to determine your monthly discretionary income, $2,649.17. If you choose a PAYE plan, your student loan payment would be 10% of your monthly student loan payment or $264.92.
The following chart illustrates how your discretionary income would be calculated in 2018 using a family size of one (single person household) for a PAYE, REPAYE or IBR Plan.
|Income||Discretionary Income||10% Loan Payment|
What Happens if I Have Little to No Discretionary Income?
If your student loan payments exceed your discretionary income, your student loan payments could be reduced to zero. Keep in mind that you are required to recertify your income every year. Most often, students connect their IRS account via StudentLoans.gov to verify the income of the previous year. If the income on your tax return increases in subsequent years, you may be required to make a payment.
What are the Downsides to IDR?
While IDR plans can decrease your payment in the short-term, there are downsides in the long-term. On an IDR plan, the life of the loan is 20-25 years. You accrue more interest and ultimately pay more than you would on a standard repayment plan.
Also, loans are forgiven after 20-25 years, and the forgiven amount is converted to taxable income. If a high balance is forgiven, you may find that you owe taxes on tens of thousands of dollars in the current tax year.
Should I Use an IDR Plan?
If your student loan payments make it difficult to pay for necessary expenses including food, rent, and utilities, then it may be a good idea to opt into an income-driven repayment plan for a time. It’s best to pay off your student loans as quickly as possible. The quicker you pay off your student loans, the less interest you will pay in addition to the original loan amount. If you can afford the standard repayment plan, it may be a better option.