Income-driven repayment is a huge benefit of the federal student loan system. Unfortunately, it’s confusing to know which plan to choose. It can be even more confusing if you have drastic income changes during your career.
When you graduate, your federal loans are put on the 10-year Standard Repayment Plan. This plan knocks out your loans in the shortest possible time. The problem is, if you’ve borrowed anything larger than about a dollar, your monthly payment amount tends to be very high.
So starting in the early 1990s, the Department of Education introduced income-driven repayment (IDR) plans, the first of which was Income-Contingent Repayment or ICR, which wasn’t the greatest. Today, there are four IDR plans to choose from, including Pay As You Earn (PAYE), Revised Pay As You Earn (REPAYE), Income-Based Repayment (IBR), and ICR.
We’ll walk you through some real examples of how to choose the right repayment plan. You’ll also learn how your payment will change as your income changes using Student Loan Planner’s free repayment calculator. It’s the best around. We’ll start with some basics you need to know before you input numbers into the calculator.
Some borrowers think of “income” as their total salary, while some borrowers think of “income” as what hits their bank account. In the world of student loans, there’s only one definition of income that matters — your Adjusted Gross Income or AGI.
This is a specific number on your tax return. In fact, if you dig out your 2020 tax return, it’s line 11 on your Form 1040.
The AGI calculation is most commonly your gross (or total) salary minus:
- Pre-tax 401(k), 403(b), or 457 retirement savings (your portion, not your employer match).
- Pre-tax or traditional IRA contributions (Roth IRA contributions don’t count).
- Health savings account.
How payments are calculated for IDR plans
How are income-based repayment amounts calculated? It depends on which IDR plan you choose, but there’s a general income-based repayment formula calculation you can start with.
1. Start with your AGI. Then, subtract 150% of the poverty level for your family size. This is your discretionary income in the student loan world.
AGI – (150% x Poverty Level) = your discretionary income
2. Once you know your discretionary income, multiply by either 10% for REPAYE or PAYE, or 15% for IBR.
[AGI – (150% x Poverty Level)] x 10% = annual payment for PAYE and REPAYE
[AGI – (150% x Poverty Level)] x 15% = annual payment for IBR
3. Divide by 12 for monthly payments.
Bonus, our free student loan calculator does all of this complicated math for you. I know some readers like to nerd out as we do, but it’s all done by the calculator, so all you really need to know is your income.
Now that we know how income is defined, and how income-based repayment is calculated, let’s look at some examples.
Scenario 1 – First timers
New to income-driven repayment? This scenario is for you.
Let’s say you’re leaving your MBA with $125,000 of federal student loan debt and are starting a job at the lower end of the spectrum to “learn the ropes.” You anticipate making about $60,000 per year, but expect your salary to drastically increase quickly — about 7% per year — for the next 10 years.
You’re currently single for the sake of simplicity (but we’ll look at a marriage example later). Here’s how your income grows, and your options for student loan payments.
When you graduate you’ll automatically be placed on the standard 10-year plan, a monthly student loan payment of $1,388 per month. That’s painful for a new professional starting at a $60,000 salary.
Using a 4% interest rate over a 20-year term, you could pay $757 per month by refinancing. You’ll have to qualify for a low refinancing interest rate like 4%, so you’ll need good credit or a cosigner.
The most favorable income-based options are REPAYE, PAYE, or IBR. REPAYE and PAYE are both 10% of your discretionary income, versus IBR which is 15% of your discretionary income. We’ll go with PAYE repayment for this scenario. A payment of $339 per month is much more manageable than $1,388.
As you see with increasing income, whether that increase is 1% per year or 7% per year, your monthly PAYE payment gradually increases.
In terms of the total cost of loan payback, the standard 10-year plan is the best option, but remember the monthly payment? It’s $1,388 per month. Yikes.
Under the PAYE scenario, you’ll start with lower monthly payments of $339/month, and eventually spend $178,121 paying your student loans back. You’ll need to save about $100 per month into a taxable brokerage account to save for the tax bomb of approximately $38,000 over the life of the loan (20 years).
If we look at today’s dollars, or net present value (NPV), PAYE is the winner, but it’s very close to the total NPV under refinancing. That’s why paying back loans from your MBA can be complicated.
Understanding you might pay between $165,000 to $275,000 for $125,000 of student loan debt, you should consider aggressively paying these back to avoid as much interest as possible, but there’s an argument for PAYE and private financing in this case.
Scenario 2 – First timer + marriage
In this scenario, our recent MBA graduate marries a nurse making $75,000 per year in 2025. They decide to file their taxes jointly. This changes our MBA borrower’s scenario significantly.
Note that the standard 10-year and private refinancing outcomes stay the same, but all three income-driven repayment options change, drastically. For example, in 2026 under PAYE, our MBA borrower’s payment jumps from $367 to $1,028 by adding their spouse’s income.
PAYE is now the worst-case scenario. The loans are off by 2039, but refinancing to a lower interest rate and paying over 20 years is the best option in terms of today’s dollars.
This scenario is a great case for filing your taxes separately. If you file separately, you’re allowed to exclude your spouse’s income from your loan payment calculation. It’s not a fit for everyone, and you can lose out on some benefits like:
- The student loan interest deduction of $2,500 — this might not be applicable to you, however, if you make a high enough income.
- More advantageous tax brackets, unless you’re in a community property state.
- Child care tax credit.
- Earned income tax credit.
- Exclusion or credit for adoption expenses.
- Ability to contribute to a Roth IRA, though you can still utilize the back-door Roth conversion method.
- Ability to deduct rental property losses.
- Ability to take the standard deduction if your spouse itemizes, or vice versa.
Scenario 3 – Leaving residency
In our final scenario, let’s shift gears and look at a drastic increase in income.
A doctor is finishing their residency or fellowship, where their income will go from about $50,000 per year to $225,000 per year. They’re working at a nonprofit hospital and got married in 2021. This borrower plans to have kids starting in 2025.
Here’s their income and repayment outlook:
As you can see, because we’re talking about income-driven repayment plans, the higher the income, the higher the payment. The standard 10-year plan would require a $4,441 monthly payment based on their $400,000 student loan balance.
Private refinancing is better at about $2,424, but IDR eases some of that burden, especially if this particular physician is working for a nonprofit hospital.
Even if this couple decides to keep their tax situation simple and file jointly, our physician still comes out on top because of Public Service Loan Forgiveness (PSLF).
Specifically, working for a nonprofit hospital through residency, fellowship, and for a few years out of fellowship can save the physician over $300,000 compared to their next best option — the standard 10-year repayment plan with that dreaded $4,000+ payment.
Shockingly, filing taxes separately from their spouse can save another $100,000.
To calculate your income-driven repayment amount, you need to know:
- Your AGI. This is found directly on your most recent tax return.
- The federal poverty line for your family size.
Things to consider:
- Your eligibility for each repayment plan.
- Your retirement savings options (Hint: it can’t hurt to save more).
- How to file your taxes (joint versus separately).
- Which state you live in. Community property states have different rules regarding taxes.
- How complicated you want your student loan plan to be.
Does this feel completely overwhelming? It’s really complicated, which is why we’re here for you. Schedule a consultation with us and we’ll review your individual circumstances. Having a customized student loan plan can take a big weight off your shoulders.