By Matthew Gaude & Shawn McGuire
Like our previous article on the Inflation Reduction Act, this article will cover the latest updates on legislative changes happening in Washington. On August 24th, 2022, President Biden announced a plan to forgive student loans for borrowers who meet certain criteria. Though the exact details of the plan are still forthcoming, there is enough information available to start planning ahead.
If you are one of the 45 million Americans who have current student loan debt, then this guide is for you. Read on to learn more about what you can expect from the student loan forgiveness program and how it can affect 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.
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.
Requirements for Forgiveness
Borrowers are eligible for this relief if their adjusted gross income is less than $125,000 or $250,000 for households from your 2020 or 2021 tax return. The good news for borrowers hoping for relief is that it is not necessary for income to be below the thresholds in both years. Rather, as long as an individual’s income was below their applicable threshold in either 2020 or 2021, they will qualify for the relief.
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.
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.
Do My Loans Qualify?
The majority of roughly 37 million borrowers, because their debt is under the William D. Ford Federal Direct Loan Program, will be eligible for forgiveness based on their loan type (and if they also fall under the income cap). That includes Direct Stafford Loans, and all Direct subsidized and unsubsidized federal student loans. Under the Direct program, Parent Plus and Grad Loans are eligible for the relief as well. The roughly 5 million borrowers with a Federal Family Education Loan (FFEL) held by the government can qualify.
Which of My Loans Will Be Forgiven First?
When forgiveness is applied, qualifying loans are prioritized as follows:
- Defaulted loans: Forgiveness will first be applied to any loans you may have defaulted on.
- Highest interest rate: The relief will then be directed at your loans with the highest interest rate.
- Loan type: Unsubsidized loans will get cancellation before subsidized loans.
Although unlikely, if all loans are the same, forgiveness will likely be applied to the most recent loan. If that doesn’t differentiate, they’ll apply to the loans with the lowest balance.
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. The main takeaway is that even if there is more forgiveness, that alone won’t 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 joint 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 net worth will increase, which is a key indicator of your financial health.
When to Apply for Forgiveness: 4 Key Dates
Earlier this month, the U.S. Department of Education said a simple application to receive that forgiveness will be ready by “early October.” In the meantime, borrowers can sign up on its website for updates on the form’s status.
Borrowers who want updates directly from the U.S. Department of Education can sign up to receive them by visiting https://studentaid.gov/debt-relief-announcement/.
November 15, 2022
According to the Biden administration, federal student loan borrowers should apply for forgiveness no later than November 15 because the Education Department estimates up to about six weeks for borrowers to get cancellation after they apply—they want their balance reduced or eliminated by the time the payment pause due to COVID-19 on federal student loans expires on December 31.
December 31, 2022
Biden also announced his intent to extend the payment pause on federal student loans until December 31, with payments to resume in January 2023. This seventh extension of the policy (which began under the Trump administration) is likely the last.
Some borrowers will still owe a monthly payment after forgiveness is applied, but the government’s income-driven repayment programs cap your monthly amount due at a share of your discretionary income, and any remaining debt after 20 or 25 years should be forgiven. Although the standard repayment plan may come with a larger monthly payment, it allows you to pay off your debt in just 10 years—if you can afford it.
December 31, 2023
Currently the Education Department says the final date to apply for forgiveness will be the end of 2023.
The following chart summarizes all important dates:
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. 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 financial professional to get the most up-to-date information.
So just as an aside for reference, the White House did send out a nice fact sheet that explains this in more detail.
Will the Student Loan Forgiveness Be Challenged in the Future?
We need to keep our eye on this because initially there was some rumbling from some Republicans and others who were concerned that this was passed through an executive order and going around Congress’ mandate. Our opinion is that they haven’t challenged it yet because the Department of Education still has to come out with final guidelines on it.
We recommend that as soon as the date in early October opens up that you go to the application and apply for forgiveness. You never know if the rules may change or if the student loan forgiveness is challenged.
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. At Live Oak Wealth Management, we are committed to providing our clients with the latest information they need to make well-informed financial decisions.
Regardless of what your student loans look like, it’s important to plan ahead. If you have questions about the new student loan forgiveness program, or would like help planning for future education expenses, please reach out to us! Call our office at 770-552-5968 or email [email protected] to get started today. Or, if you prefer, you can simply click here to schedule an appointment online.
Matthew Gaude is an *investment advisor representative and the co-founder of Live Oak Wealth Management, a financial services firm in Roswell, Georgia. He serves the planning and investment needs of corporate employees, those approaching or in retirement, and 401(k) plan sponsors. Working first as a commodity broker and then as a Business Development Manager for a national broker-dealer in previous jobs, he has the insight and experience to help clients understand the complexities of the market and implement strategies to minimize risk. To learn more about Matthew, connect with him on LinkedIn or visit www.liveoakwm.com.
Shawn McGuire is a financial advisor and the co-founder of Live Oak Wealth Management, a financial services firm in Roswell, Georgia. He serves the planning and investment needs of corporate employees, those approaching or in retirement, and 401(k) plan sponsors. He has worked in financial services since 2002 in positions ranging from financial advisor to stock broker and portfolio manager. As a CERTIFIED FINANCIAL PLANNER™ professional, he is trained to help clients with virtually all their financial needs. To learn more about Shawn, connect with him on LinkedIn or visit www.liveoakwm.com.
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