By Jim Shellenberger, CFA CFP®
After months of speculation, on August 24th, 2022, President Biden announced a plan to forgive student loans for borrowers who meet certain criteria. The plan also includes a final extension of the national student loan payment pause, which will delay further payments until January 2023.
With payments on hold and forgiveness seemingly imminent, many borrowers may think they are in the clear. However, we caution against making any major financial decisions before understanding the details and requirements of the plan. Here is what you can expect from the new forgiveness program and how it can impact your long-term finances.
How Much Forgiveness Should You Expect?
The plan would provide up to $20,000 of debt forgiveness for students who receive a Pell Grant, and $10,000 of forgiveness for non-Pell Grant recipients. (1)
Pell Grants are offered to low-income and middle-income students based on financial need, and the amount awarded to students does not need to be paid back. According to the White House, approximately 60% of people who have federal student loans received Pell Grants. (2)
Requirements for Forgiveness
Borrowers are eligible for this relief if their individual income is less than $125,000 or $250,000 for households.
Private student loans are not eligible, only federal student loans. Of the $1.75 trillion of debt Americans have in student loans, roughly $1.62 trillion is from federal student loans while the remaining $131 billion comes from private loans. (3)
There is no age requirement, nor does the plan stipulate that the borrower must be the one who used the loan for college. That means that parents, or grandparents, who took out student loans for family members would be eligible for forgiveness, so long as they met the income requirements.
The plan also stipulates that the reprieve is only for those who took out loans prior to June 30th, 2022. Thus, no loans taken after that date would be eligible for forgiveness under this plan. It is currently unclear if there will be future loan forgiveness plans.
The Department of Education said that the application to apply for forgiveness will end on Dec. 31, 2023. To be notified of when the application opens to apply, you can sign up at the Department of Education subscription page. (4)
Additional Student Loan Changes
The plan also made changes to the repayment of federal student loans, including:
- Lowering the percentage borrowers pay of their monthly discretionary income from 10% to 5% (only for undergraduate loans).
- Forgiving loan balances after 10 years of payments if the borrower has a balance of $12,000 or less.
- Paying for a borrower’s unpaid monthly interest. Some borrowers have paid their monthly payments but have seen their balances grow because of the interest. Now, as long as they make their payment, their balance will not grow.
Planning for Future College Expenses
Despite the $10,000 to $20,000 debt forgiveness coming to certain borrowers, it is still advisable to plan for other ways to pay for the cost of a college education. In 2021-2022, the average cost of an in-state public college was $10,388, while an out-of-state public college was $22,698. The average private college cost was $38,185. (5) The main takeaway is that even if there is more forgiveness, that alone may not be able to cover the full cost of 4 years in college.
Two of the most popular ways to save for college are a 529 plan and the Coverdell Education Savings Account (ESA); each offers tax benefits and can be suitable for savers.
A 529 plan allows for borrowers to invest contributions into an account, invest it with tax-deferred growth, and withdraw the money tax-free as long as the money is used for a qualified education expense. Additionally, some states offer a tax deduction on contributions made to 529 plans.
The ESA contributions are not tax-deductible, but like a 529, your contributions grow tax-deferred, and distributions used for qualified education expenses are tax-free.
The ESA has a $2,000/year contribution limit, while there is no contribution limit for the 529 (although you do need to ensure you don’t exceed any gift tax limits, and if you do, you’ll need to report it on your tax return).
If You Qualify for Forgiveness
If you qualify and your new student loan balance will be fully paid off, this is a great time to take the next step in your financial life. Instead of immediately spending the money previously contributed to student loans, consider using that money to invest and build wealth. Depending on your goals and circumstances, you can contribute to your workplace retirement plan, an IRA, or a taxable investment account.
If you qualify but the amount forgiven will lower but not eliminate your loans, there is still plenty of good news. Not only is your loan balance lower, but the amount of interest you pay each payment will decline, which will increase how quickly you can pay off your principal.
Also, as a result of your lower loan balance, your can still increase your net worth, which is a key indicator of your financial health. (6)
Your Forgiven Debt May Be Taxed by Your State
For those who do have student loan debt forgiven, you will not owe any taxes on the federal level on the amount forgiven. For instance, if you receive $10,000 in debt forgiveness, you will not have to include the forgiven amount in your taxable income on your federal tax return. Additionally, most states follow that rule when it comes to your state tax returns; thus, there won’t be an additional tax owed because you qualified for forgiveness.
However, that’s not the case in every state. Currently there are seven states where your forgiven amount would be included in your taxable income on the state level: North Carolina, Indiana, Mississippi, Arkansas, Minnesota, Wisconsin, and California. (7) While this reflects the law as it stands today, each of these states could change how forgiveness is taxed as they gather more information on the plan and make adjustments to their states law. If you have questions about the tax implications of student loan forgiveness in your state, please contact a tax professional to get the most up-to-date information.
We Can Help
The full details of the student loan program will be provided in the next few weeks and months, and we will be in touch as we learn more. If you are a young professional with student loan debt, or if you would like more information on how forgiveness will impact you, please reach out to us!
No matter what your student loan situation is, Elevate Wealth Management can help you plan for the future. Schedule an introductory meeting by reaching out to us at jshellenberger@frontierasset.com or 307.673.5675.
About Jim
Jim Shellenberger, CFA, CFP® is a financial advisor at Elevate Wealth Management, an independent, fee-only wealth management firm serving young professionals, pre-retirees, and retirees in Sheridan, Wyoming, and surrounding areas. With the mission of serving and educating, Jim is dedicated to providing comprehensive, top-notch services that not only help his clients reach their goals, but also empower them to make the best financial decisions for their lives and walk toward their future with confidence. Jim is known for going the extra mile, not only offering valuable knowledge in investment management as a former investment analyst, but building long-lasting relationships so he can give honest, customized advice and strategies that make an impact on their lives.
Jim has a bachelor’s degree in business administration with a minor in finance from the University of Wyoming. He is proud to be a Wyoming native and loves exploring the outdoors with his family—hiking, fishing, hunting, and backpacking. Faith is an integral part of Jim’s life, and he always looks forward to attending church on Sundays, Bible study on Fridays, and being part of his church community. He’s also an avid sports fan! Fun fact: Jim owns shares in the Green Bay Packers. To learn more about Jim, connect with him on LinkedIn.
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(1) https://studentaid.gov/debt-relief-announcement/
(3) https://www.forbes.com/advisor/student-loans/average-student-loan-statistics/
(4) https://www.ed.gov/subscriptions
(6) https://www.cnbc.com/select/what-is-net-worth/
(7) https://www.npr.org/2022/09/09/1121717824/biden-student-loans-debt-cancellation-taxpayer-impact