How to lower your student loan payments by saving for yourself
Balancing repaying your student loans with savings is a challenge. This is especially true if you’re on an income-driven repayment plan. These are the plans that set your monthly payment as a percentage of your discretionary income — such as Income Based Repayment, Pay As You Earn, and RePAYE.
However, there are several tools that you can use to both help you save money AND lower your student-loan payment. And it's getting close to the time when most Americans can opt into these tools.
We’re talking about using tax-advantaged accounts like a 401k, Health Savings Account (HSA), and more to save for yourself, but also to lower your student-loan payment at the same time. How does that work? Let’s break it down.
How saving for yourself can lower your student-loan payments
When you’re on an income-driven repayment plan, your monthly payment is based on your discretionary income. Discretionary income is the money you have left after paying your “necessary” expenses. This number is based on your Adjusted Gross Income (AGI), which is calculated from your tax return, the government-set poverty level, and your household size.
You can control two of these — your AGI and your household size. But in practice, AGI is much easier to control that household size, and I don’t think it’s wise to have children or get married for the sake of your student-loan payment.
With that being said, if you lower your AGI, you have the potential to lower your discretionary income, which will lower your monthly student-loan payment.
* There is a full discretionary income calculator to let you figure out some of the math.
How does lowering your AGI lower your payments?
Here’s how it looks in practice. Let’s take a basic example.
If you have $50,000 in student loans, and your AGI is $50,000 per year, you could qualify for Pay As You Earn (PAYE) with a monthly student-loan payment of $265 per month.
If you can lower your AGI to $46,000 per year (which is very doable), then your monthly payment would drop to $232 per month — a savings of $33 per month.
That’s not a huge drop, but it helps, and will save you almost $400 per year on your student-loan payment. But there’s an added benefit — you did this by paying yourself! That means you didn’t pay your lender more money, or pay more in taxes, but rather, you saved your own money to make that drop happen.
The types of tools that can help you
There are several different accounts that will help you lower your AGI while saving for yourself. Depending on your employer, you may have access to some of these accounts. Others, like a traditional IRA, don’t require an employer to participate in.
- 401k or 403b — Most employers offer a 401k or 403b for their employees. With this account, you can save money for retirement, and your contributions can be pre-tax, meaning they lower your AGI. The great thing about these accounts is that many employers match your contribution, meaning not only can you save money and lower your student-loan payment, but you can also get a bonus payment from your employer.
- Thrift Savings Plan (TSP) — A TSP is a similar account to a 401k for government employees. It works in a similar fashion, with pre-tax contributions lowering your AGI.
- Health Savings Account (HSA) — This is a plan that allows you to contribute money to pay for health-care costs you might incur. It can also be used as a retirement savings vehicle. But, like the other options, money contributed to this account is pre-tax, and so it will lower your AGI. Make sure you understand the HSA Contribution Limits† for your situation.
- Flexible Spending Account (FSA) — An FSA is a plan that allows contributions to be made pre-tax for various activities. One of the main ones is health care (as an alternative to an HSA), but there are also FSAs for day-care expenses, transportation expenses, and more. If you can contribute to an FSA and it makes sense to do so, it will also lower your AGI and help lower your student-loan payment.
- Traditional IRA — This is an individual retirement account that allows you to make pre-tax contributions to save for the future. This account isn’t offered through an employer, but you do have to have earned income to contribute. You can open this account at any investment broker. Since the contributions to the account are pre-tax, it will also lower your AGI.
Is this a solution for everyone?
Saving for yourself is always a solution for everybody, but these account contributions will lower your student-loan payments only if you’re on an income-driven repayment plan. Since you have to certify your income annually, if you can lower your AGI, your new discretionary income will reflect on your updated student-loan payment.
If you’re on other student-loan repayment plans, such as the Standard 10-Year Plan, Extended Plan, or Graduated Plan, these tools will not help you lower your payments since they are set on a schedule vs. being based on your income.
With open enrollment approaching for many Americans, now’s the time to opt into some of these savings vehicles that can also help you lower your student-loan payments.
Saving for yourself is always a good thing, and finding the financial balance to make it happen will result in a long-term win for your future.
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