Income-Driven Repayment & How to Hack Your Student Loans

Student loans got you down?

If so, you can get in line with the other 44 million Americans.

Fortunately, there are a few strategies you can use to not only lower your income-driven student loan payments (aka income-driven repayment) but save buckets of money, too!

In case you don’t know what I’m talking about here, income-driven repayment plans are government-backed plans that let borrowers pay back a percentage of their “discretionary income” toward their student loans for up to 25 years. Once their program is up, their remaining loan balances will be forgiven.

The only caveat to note here is that, with income-driven repayment plans, you do have to pay income taxes on forgiven loan amounts during the year they were forgiven.

If you want to get the most out of one of these plans, there are several strategies you can try. Keep reading to learn how to hack income-driven repayment plans for maximum value.

Max Out Your Employer-Provided Retirement Plan to Hack Income-Driven Repayments

An easy first step to lowering your income-driven student loan payment is to put the maximum into your traditional 401(k), 403(b) or 457 plan. If you’re under age 50, you can sock away $18,500 in 2018.

You may be wondering if this makes any sense at all. After all, wouldn’t putting money into your 401(k) mean you have less cash to make your student loan payment?

Not exactly.

This is because your income-based repayments are based on your adjusted gross income or AGI. This is the amount of income you’re taxed on after certain taxable deductions.

Small Loan Payments, Fewer Taxes, and Saving for Retirement

When you put money into a traditional 401(k) or traditional 403(b), your adjusted gross income goes down. And since your income-based repayments are based on your adjusted gross income (and not your gross income), you may qualify for smaller payments on your income-based repayments.

As an added bonus, you’re saving for retirement when you put money into these kinds of accounts. As a third benefit, putting money into a traditional 401(k) or traditional 401(b) means you’ll be paying less in taxes that year.

Free Money from Your Employer

There is also a possible fourth benefit; you may be able to get free money from your employer when you fund your 401(k) account. This is due to the fact that many employers offer matching funds for workers who contribute to their retirement accounts.

Four Benefits of Maxing Out Your 401(k) with Income-Based Repayment

This is such a big deal that I really feel I need to break it down again. When you put money into your traditional 401(k), etc., you:

  • Save money on taxes
  • Score a smaller income-driven repayment payment
  • Save for retirement
  • Potentially get free money from your employer

Let’s say it again: Fewer taxes, free money, a smaller income-based repayment, and saving for retirement! It’s a quadruple win.

Still, there’s one variable to note here – the difference between saving in traditional or Roth retirement accounts.

Normally, we’d advise clients to only ever to contribute to Roth accounts, and not traditional retirement accounts. However, this can mean giving up the benefit of lower income-based repayments.

So, if the option is to not save in any retirement account at all because the college payments are so punishing, or save in traditional retirement accounts, I’ll choose saving every day of the week.

Max out a Traditional IRA

Just like maxing out a traditional retirement plan lowers your adjusted gross income, your income-based repayment, and the taxes you owe Uncle Sam and possibly the state government, putting money into traditional IRA can do the same as well.

You can lower your taxes, save for retirement, and decrease the amount going towards income-based repayments if you put money into a traditional IRA (and your income is low enough you can deduct the full amount on your taxes).

Max out a Health Savings Account

When you max out a health savings account (HSA), you get all the benefits above and then some.

Putting money into an HSA means you’re using a high deductible health plan (HDHP), which means that you’ll be paying less for the cost of health insurance.

You may also be able to save money on payroll taxes if you make HSA contributions through your employer via automatic paycheck deductions.

Go for the Trifecta

Imagine you wanted to use all the strategies listed above – investing with an HSA, traditional IRA (assuming certain income limits), and a traditional 401(k).

Contributing to all of these accounts will lower your adjusted gross income and help you pay less in taxes.

Even better, contributing to these accounts when you are on income-driven repayment plan helps you pay less toward your student loan bills, too.

To sum things up, going for the trifecta can benefit you in more than one way:

  • It reduces your taxable income, meaning you will pay less in taxes. This will save you considerable sums of money every year that you contribute to these accounts.
  • If you’re using an HSA, it means you have an HDHP – which on average will save you money on the cost of health insurance every year that you use it.
  • You get the benefit of saving for retirement, which is something that most people don’t do enough of.
  • Each of these accounts grows tax-deferred. This means that, while your money grows inside the account, you pay zero taxes.
  • You can decrease the amount of your student loan payment since you’ve slashed your adjusted gross income. You can pay less in taxes and pay less toward your student loans.
Disclaimer: This article is for informational and entertainment purposes only. None of this is to be considered tax advice. Before you try to lower your AGI in an effort to pay less toward your student loans, speak with a qualified tax professional.