RAP student loan plan may increase your payments. Tax planning can help
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With a little strategy, federal student loan borrowers can lower their monthly bills under the U.S. Department of Education’s new repayment plan coming July 1.
Under the Repayment Assistance Plan (RAP), borrowers pay a higher percentage of their income as their earnings increase. That means finding ways to reduce your pre-tax income by even a small amount can lower your monthly student loan payments, said Landon Warmund, a certified financial planner and certified student loan specialist at Reliant Financial Services in Kansas City, Missouri.
“This definitely has some unique opportunities,” said Warmund, a member of CNBC’s Council of Financial Advisers.
Figuring out how to reduce your monthly loan bill under RAP may be especially important for millions of borrowers forced to leave the Biden-era Value Education Savings, or SAVINGS, plan. A federal appeals court ended SAVE, the most affordable repayment plan ever, earlier this year.
Student loan borrowers must exit SAVE within about 90 days starting July 1, and many will face higher required payments under other plans.
“Borrowers can try to avoid these payment increases by exploring what pre-tax benefits are available to them at work to reduce their taxable income, which would keep them below their base income figures,” Warmund said.
Here’s how borrowers can try to reduce their payments under RAP.
How does RAP calculate your monthly bill?
Under RAP, monthly payments will typically range from 1% to 10% of your earnings; The more you do, the larger your required payout will be. A minimum monthly payment of $10 will be due for all borrowers.
Current income-driven repayment plans, or IDRs, offer $0 monthly payments to some very low-income borrowers.
RAP also does not preserve a portion of the borrower’s income in the bill calculation for necessary expenses, as other IDR plans do; instead it determines the payment based on: adjusted gross income. AGI is your total pre-tax earnings minus certain deductions.
For RAP enrollees, “even a single dollar difference in AGI can result in an impact of several hundred dollars in terms of total student loan payments in a year,” Warmund said.
For example, because of RAP’s formula, a student loan borrower with an annual AGI of $59,999 may pay about $50 more per month, or $600 per year, than a borrower with an AGI of $60,000, he said.
How can you reduce your adjusted gross income?
There are a variety of ways borrowers can reduce their APR and therefore their monthly RAP bill, said Carolina Rodriguez, director of the Education Debt Consumer Assistance Program in New York, a nonprofit organization that helps borrowers.
One method is to direct a portion of your paycheck to your workplace 401(k) retirement plan or traditional IRA, or to increase your contributions to those accounts, Rodriguez said. Remember: To lower your AGI, these contributions must be pre-tax or deductible, so money put into a Roth IRA or Roth 401(k) won’t help here.
If a single student loan borrower reduced their AGI from $71,000 to $69,999 by contributing an additional $1,001 per year to their pre-tax retirement account, their monthly payments in the RAP would drop from $414 to $350, Warmund said.
The RAP plan has many good benefits if you plan accordingly.
Landon Warmund
Certified financial planner
Making pre-tax contributions to a health savings account or HSA or flexible spending account or FSA are additional options for lowering your taxable wages, Rodriguez said. Companies may offer several types of FSAs, including qualification. healthcare, dependent care and transportation costs.
Meanwhile, if you’re self-employed, claiming legitimate business expenses and deductions on Schedule C can lead to the same result, Rodriguez said.
“This may include ordinary and necessary business expenses, retirement contributions and health insurance deductibles,” he said.
Other “above-the-line” deductions, including the deduction for student loan interest, can also lower your AGI.
Save $50 per dependent
Under the RAP plan, federal student loan borrowers can reduce their monthly bill by $50 for each dependent they claim, Rodriguez said. Dependents are usually minors but may also include: siblings or other relatives in certain casesPer IRS guidelines.
These savings should be automatic and tied to your tax return.
“This is based on the number of dependents the borrower claims on their federal tax return,” he said.
You can still pay more over time
Even if you can lower your monthly payment under RAP, you may have to pay more over the life of the loan than under other plans, Rodriguez said. That’s because RAP only provides student loan forgiveness after 30 years, compared to the typical 20 or 25-year timeline for other IDR plans.
As a result, some borrowers may request to compare monthly bills and the total amount of payments made through RAP to other repayment plans. However, RAP will be the only IDR plan available for student loan borrowers who took out loans after July 1.
Borrowers with existing federal student loans may continue to have access to: some current IDR plansIncluding Income Based Repayment plan or IBR. IBR borrowers are eligible for debt forgiveness after 20 years or 25 years, depending on the maturity of their loan.
while Income Conditional Repayment plan or ICR and PAYMENTor the Pay As You Earn scheme will also remain available to existing borrowers until mid-2028; Neither program now results in debt forgiveness. The only reason you want to be in either plan is if it gets you the lowest monthly payment, Rodriguez said.
If this is the case, you can remain in ICR or PAYE until the plans expire on 1 July 2028. If you later switch to IBR or RAP, you will be eligible to receive a forgiveness credit for your previous payments.
“If RAP is going to be your lowest option, wait until it becomes available,” Rodriguez said. “But beware of the consequences of the plan.”
