“How long will it last?”

How many times did we ask that question over the last few years? Not only about the pandemic, but also about the pause on student loan payments.

And finally, we have a definitive answer: In late June, the Supreme Court struck down President Biden’s student loan cancellation plan. The pause on payments that started in March 2020 will come to end on August 31, 2023. This means borrowers must now prepare to start making their monthly payments again.

The good news is, there are some programs in place that should help reduce the burden for borrowers as they resume their payments.

Restarting payments

First off, borrowers should make sure they are set up to begin making student loan payments starting in September. However, it is important to note that the Biden administration is providing an “on-ramp” period from October 1, 2023 to September 30, 2024 to help borrowers ease back into these monthly payments.

During this period, loan payments will be due, and interest will accrue, but if borrowers miss payments, they won’t be considered delinquent, placed in default, referred to debt collection agencies, or reported to credit bureaus. While this does provide some breathing room, financial professionals should encourage clients to begin payments as soon as possible and only use this option as a last resort.

Department of Education introduces SAVE repayment plan

The second item advisors should begin discussing with clients is the new income-driven repayment (IDR) plan known as the “Saving on A Valuable Education,” or SAVE Plan, launched by the Biden administration in July.

The SAVE Plan is a modification to the existing REPAYE (Revised Pay As You Earn) Plan, and anyone who was previously part of REPAYE will now be covered by the SAVE Plan. Also, borrowers who are using other IDR plans will have the ability to switch to SAVE if they hold federal student loans. (Note that SAVE does not apply to Parent PLUS loans.)

What to know about SAVE

The main change from REPAYE to SAVE is the percentages used to calculate payments. Under REPAYE, monthly payments were limited to no more than 10% of discretionary income, which was defined as household adjusted gross income (AGI) above 150% of the Federal Poverty Level (FPL) for that household size, divided into 12 monthly payments.*

Under the new SAVE Plan, borrowers will only pay 5% of discretionary income on loans used for undergraduate education. (The percentage of discretionary income remains at 10% for loans used for graduate education.) The threshold for discretionary income also changes to 225% of the FPL.

This change can provide significant savings for any borrow, regardless of income. For example, the FPL for a single person in 2023 is $14,580. That means borrowers making less than $32,805could save around $90 per month while their monthly payment decreases to $0 per month. But even those with significantly higher incomes stand to benefit.  For example, an individual earning $150,000 per year would save nearly $600 per month through the new program as their payments go from $1,067 to $488 per month.

It’s important to note, however, that the calculations get a bit more complicated for those who have a combination of undergraduate and graduate loans. Those borrowers would need to use a weighted average to figure out what overall percentage of annual discretionary income would be used to calculate payments.

For example, if someone had $20,000 in undergraduate loans and $50,000 in graduate loans, percentage would be calculated as follows:

(5% x ($20,000/$70,000)) + (10% x ($50,000/$70,000) = 8.6% (percentage multiplied by discretionary income figure)

Elimination of negative amortization

Another important change under the SAVE Plan is the elimination of negative amortization. Based on the new lower payments amounts, many borrowers’ payments may not fully cover the interest being charged on a monthly basis. This means that any remaining interest won’t be added to the principal of the loan.

This is important for a couple of reasons. First, borrowers won’t see their loan balance grow even as they are making all their scheduled payments. Second, through SAVE, loan amounts may be forgiven after 10 to 25 years of payments (more details on that below). The amount that is forgiven is included as taxable income, and through the elimination of negative amortization, that amount will never be more than the original loan amount.

Loan forgiveness

As mentioned, loans that were part of the REPAYE federal repayment program are eligible for forgiveness under SAVE. The Department of Education will continue to forgive loans after 20 years for borrowers with only undergraduate loans, and for 25 years for those with any graduate loans. But with the implementation of SAVE, there is one additional tier: If the combined original balance of all loans – undergraduate and graduate – being paid under the plan is $12,000 or less, the loans are forgiven after making payments for only 120 months (10 years).

Planning considerations for advisors and clients

Another part of the calculus that should go into planning around student loans and the SAVE Plan is how clients choose to file their taxes. SAVE allows those who file taxes as married filing separately (MFS) to exclude their spouse’s income when calculating their monthly loan payments. This could provide the opportunity for significant savings for couples where the lower earning spouse has student loan debt. Of course, MFS may disqualify couples from taking advantage of certain credits and the higher standard deduction. Still, I would encourage advisors and clients to work through both scenarios to figure out if savings can be gained.

From a longer-term standpoint, the new SAVE Plan may change the way parents save for college – especially given that borrowers won’t have to pay more than 5% of their discretionary income after college and those loans will be forgiven after 20 or 25 years. In fact, Kent Smetters, Boettner Chair Professor at the University of Pennsylvania’s Wharton School noted that, because of the SAVE program, many borrowers may skip funding a 529 account all together and simply take out as much as they need in student loans.¹

Of course, you may have clients who say, “Wait, I already have money in a 529 plan, I have to do something with it.” In that case, they could certainly use their 529 plan assets for college tuition or take advantage of the 529-to-Roth transfer options available through SECURE 2.0.

Overall, while it may not be the full forgiveness many student loan borrowers had hoped for, the SAVE Plan is a useful program that can lead to significant savings. As borrowers prepare to restart their payments, they should educate themselves on the new program and talk to their financial professional to determine whether the plan’s provisions could benefit them.

 

*Note: Hawaii and Alaska have different FPL guidelines.

¹ “How Student Loan Forgiveness Will Transform College Financing.” Knowledge at Wharton Podcast, September 13, 2022.

IMPORTANT INFORMATION

The information contained herein is for educational purposes only and should not be construed as financial, legal or tax advice. Circumstances may change over time so it may be appropriate to evaluate strategy with the assistance of a financial professional. Federal and state laws and regulations are complex and subject to change. Laws of a particular state or laws that may be applicable to a particular situation may have an impact on the applicability, accuracy, or completeness of the information provided. Janus Henderson does not have information related to and does not review or verify particular financial or tax situations, and is not liable for use of, or any position taken in reliance on, such information.

Investors should consider, before investing, whether the investor’s or designated beneficiary’s home state offers any state tax or other benefits that are only available for investments in such state’s qualified tuition program.