By Becca Craig, CFP
The rule (or power) of three is an age-old maxim in rhetoric and other disciplines which states that things that come in threes are inherently more satisfying to us. If that’s indeed the case, do I have some good news for you: The pause on student loan repayment, interest and collections has been extended for a third time, until Jan. 31, 2022. The Biden administration and the U.S. Department of Education are adamant this will be the final extension, leaving many Americans anxious about their repayment strategy and how student loan debt will shape their long-term financial future. Especially sensitive to legislative and political issues surrounding student loans are retired and senior citizen borrowers.
The amount of student loan debt held by baby boomers has reached an all-time high, and it increased by 33% from 2019 to 2020. These figures include federal and private loans that baby boomers took out in their own names for their children’s college educations, commonly Parent PLUS loans. In pre-pandemic 2020, baby boomers had the highest average monthly student loan payment of any generation. Many older Americans still find themselves asking questions about the best way to pay off student loan debt in retirement.
The answer (as with all questions regarding student loans) is that it depends. There are various strategies and many options to consider if you find yourself nearing your golden years saddled with student loans (either your own or your child's). The good news is that you can take certain steps to wrest control of your repayment plan in retirement and that federal loan borrowers now have time on their side with the student loan payment and interest pause having been extended. Keep in mind, though, that if you refinance to a private loan at this time, interest accrual and payments would start immediately.
So slow down, define your goals, and make a sustainable, palatable payment plan for the long haul. Consider the following:
Take an inventory
Most individuals would not execute a major change to their investment portfolio without sufficient deliberation or purchase real estate without first conducting a thorough inspection. Prior to deciding what to do with your student loans, it’s important to understand what type of loans you actually have, the amount you actually owe, and your current repayment plan. While your loan servicer’s statements and loan documents are nice, the most effective tools for assessing the current state of your student loans are either your credit report (for private loans) or the National Student Loan Data System (NSLDS®) database report (for public loans).
Define your student loan repayment goals
The "best" repayment strategy depends on a variety of factors, but most important is your big-picture financial goals. There are many paths available, and all the options have tradeoffs, risks and rewards depending on your circumstances, financial values and personal goals. Ask yourself what is most important:
- Establish a fixed, affordable monthly payment?
- Minimize the total cost of debt over time?
- Improve your credit report?
- Qualify for student loan forgiveness?
Define your repayment strategy
If you owe a relatively small amount on federal or private student loans and can afford monthly payments, you could focus on minimizing the (eventual) interest charges over time by paying down the debt quickly, prioritizing more expensive loans, and avoiding capitalization.
But if your debt-to-income ratio is high or if you have a large student loan balance, you might consider aligning your strategy to the goal of eventual loan forgiveness. Without understanding their options, some seniors might try to pay student loan debt in full as soon as possible. While that’s a common desire, some borrowers could find themselves continuing to make payments without moving the needle, chunking lump sums toward debt all while sacrificing their lifestyle in retirement.
If you are considering retirement but are fearful that you will not be able to keep up with your monthly federal student loan payments as they are, you could consider a long-term (20- to 25-year) income-driven repayment plan. Most federal student loans are eligible for at least one of the four income-driven repayment plans. If your income is low enough, your payment could be as low as $0 per month.
Unlike standard, extended and graduated repayment plans, monthly payments are not based on an amortization schedule of the total amount owed. The monthly payment is a separate calculation, using the borrower's adjusted gross income (AGI) and family size. After 20 or 25 years of repayment on an income-based repayment plan, the remaining balance of the loan principal and interest is forgiven and written off as taxable income. The borrower will owe taxes on the amount forgiven.
There are many factors to take into consideration when looking at an income-driven repayment plan, including the type of loans you have and interest capitalization when changing repayment plans. Make sure to consult with a student loan planning professional to take all your options into account and understand how they will affect the big picture.
What about Parent PLUS loans?
Parent PLUS loans have gained popularity in the past 10-15 years, as many baby boomers used them to pay for their children's education. As the amount of outstanding Parent PLUS loans has increased, so too has the need to better understand how best to repay them.
Parent PLUS loans typically come with relatively higher interest rates and higher monthly payments. Some advocate for the Parent PLUS double consolidation loophole strategy, which allows loan holders to use repayment plans that only collect 10-15% of their income as opposed to the typical 20% through income-contingent repayment. This strategy requires a borrower to have at least two outstanding loans and can take anywhere from six to 18 months to complete. The process is tedious and complex, and ought to be fully understood before it is pursued. Still, it could benefit certain senior citizens living on a fixed monthly budget.
Should you consolidate your federal loans?
Direct consolidation allows borrowers to retain many of the unique benefits of a federal student loan, along with other consumer protections such as forbearance or deferment (where all federal loans are currently). When borrowers consolidate federal student loans to a direct consolidation loan, the government exchanges their previous loans for a single, new loan. The borrower’s interest rate on the consolidated loan is a weighted average of the rates on their prior loans, rounded up by one-eighth of 1%. In short, when a borrower goes this route, direct consolidation adds around 0.125% in interest.
The benefit of consolidating direct or GRAD loans is having only one loan. If that's a priority for a senior borrower, then consolidation is an option, but added interest is a factor to consider. If a borrower is eligible for Public Service Loan Forgiveness, consolidating loans cancels any and every qualifying payment made previously. For that reason, those nearing retirement likely should not consolidate loans that would otherwise be forgiven income tax-free.
So, in practice, consolidating is typically most beneficial when used with Parent PLUS loans in a double-consolidation strategy to gain access to different repayment plans. If you consolidate multiple loans, you'd lose the ability to build a strategic repayment plan. Some borrowers like the idea of paying more to lower-interest loans should they be aiming to pay their loans off in full, which would not be possible with a direct consolidation loan.
Should you consider refinancing federal loans to a private student loan?
During someone’s earning years, the appropriate repayment strategy really comes down to the loan holder’s student loan repayment goals (e.g., manageable monthly payment versus paying them off as soon as possible), their current payment capacity (i.e., desired monthly payment), current AGI (to calculate income-driven repayment plan projections), and earnings potential over the next 10-25 years (to calculate total outlay of income-driven repayment plans).
This is not the case for retirees and seniors. With many private student loan refinancing companies offering all-time low rates, these offers can be very appealing for retirees solely focused on lowering monthly payments.
If a borrower is financially sound, with a goal to pay off the loans quickly as possible, refinancing to a private loan strategy might make sense. This is especially true in cases where the borrower currently has private student loans with relatively high interest rates. Still, federal student loans are guaranteed certain protections that private loans are not. Private loans offer lower interest rates through refinancing, but the total amount must be repaid, with very, very little hope for forgiveness.
One more caution: Most private loans do not have discharge protections for death or total disability. Private student loan obligations can be reassigned to a cosigner or passed on to other family members. This is something to take into consideration should you find yourself nearing your projected life expectancy.
Other items to consider
Those considering retirement or who are in retirement often maintain a fixed spending budget. Others who find themselves in a lower tax bracket with decreased earned income might now be able to take advantage of the student loan interest deduction. Single filers with modified adjusted gross income (MAGI) less than $70,000 ($140,000 if filing jointly) are allowed to deduct up to $2,500 in paid student loan interest from their taxable income. The student loan interest tax deduction is an above-the-line dedication (not itemized).
Due to the pandemic and the resulting CARES Act, interest accrual on most federal student loans has been paused since March 2020. That being said, all good things must come to an end and repayments and student loan interest will eventually come back in to play.
Doublecheck your qualification for the Public Service Loan Forgiveness (PSLF) Program or Temporary Expanded Public Service Loan Forgiveness (TEPSLF)
PSLF forgives the entire balance (income tax-free) of all federal student loans after borrowers make 120 qualified payments using a qualified repayment plan (income-driven repayment) while working for a qualifying employer (and certifying it each year). Past payments (including the non-payment months of COVID) count toward the 120 total payments if the borrower was enrolled in an income-driven repayment plan. And remember, if a borrower consolidates their current loans, they will lose credit for any payments made toward income-driven repayment plan forgiveness or Public Service Loan Forgiveness.
If you plan to work for a few more years or have worked your career in a Public Service Loan Forgiveness program qualifying area, consider applying for public service loan forgiveness or temporary extended public service loan forgiveness. Holders of Parent PLUS student loans can qualify based on their employment even if their child would not. Despite the complexities, pursuing public service loan forgiveness could be worth the time and additional sweat equity if it means riding into retirement free and clear of student loan debt.
At the end of the day, the "right" action comes down to a borrower's goals for their student loan repayment strategy, the options available to them, and their larger retirement plan. If you’re in or nearing retirement, consider working with a professional to give yourself the best odds of living the golden years you envision.
About the author: Becca Craig, ABA, CFP®
As an advisor with Buckingham Strategic Wealth, Becca Craig, ABA, CFP®, combines her experience in wealth management with her background in public policy and risk management to better educate investors using a holistic approach to financial wellness. A champion and advocate of evidence-based planning, Becca enjoys making people's money work for them – not against them – so they can focus on the people, endeavors and causes they care about most.
Important Disclosure: The opinions expressed by featured authors are their own and may not accurately reflect those of Buckingham Strategic Wealth®. This article is for general information only and is not intended to serve as specific financial, accounting, legal, or tax advice. Individuals should speak with qualified professionals based upon their individual circumstances. The analysis contained in this article may be based upon third-party information and may become outdated or otherwise superseded without notice. Third-party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a qualified professional based on his or her individual circumstances. IRN-21-2662
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