Millennials are not the only ones saddled with the obligation to pay back massive amounts of student loans. Many parents take out loans in their names to help their children pay for college, and in many cases, these loans are getting in their way of achieving their goals, like retiring.
Under the federal student loan system, parents can take out Parent PLUS loans for their dependent undergraduate students. One of the major differences between Parent PLUS loans and the loans that the students take out is that there are fewer repayment options available for Parent PLUS borrowers. Parent PLUS loans are only eligible for the Standard Repayment Plan, the Graduated Repayment Plan and the Extended Repayment Plan.
There are other strategies for managing Parent PLUS debt, however. When consolidated into a Direct Consolidation Loan, Parent PLUS loans can become eligible for the Income-Contingent Repayment (ICR) Plan, in which borrowers pay 20% of their discretionary income for up to 25 years.
Currently, ICR is the only income-driven repayment plan that consolidated loans repaying Parent PLUS loans are eligible for. However, when a parent borrower consolidates two Direct Consolidation Loans together, the parent can potentially qualify for an even better repayment plan and further reduce their monthly payments.
Nate, the high school math teacher
Let’s take a look at Nate, age 55, as an example to see how a parent can manage Parent PLUS loans and still retire as hoped.
Nate is a public school teacher who makes $60,000 a year and just got remarried to Nancy, who is also a teacher. Nate took out $130,000 of Direct Parent PLUS loans with an average interest rate of 6% to help Jack and Jill, his two kids from a previous marriage, attend their dream colleges. Nate does not want Nancy to be responsible for these loans if anything happens to him, and he is also worried that he would not be able to retire in 10 years as he had planned!
If Nate tried to pay off his entire loan balance in 10 years under the federal standard repayment plan, his monthly payment would be $1,443. Even if he refinanced privately at today’s historically low rates, his payments would still be around $1,200, which is too much for Nate to handle every month. Also, since Nate’s federal loans are in his name only, they could be discharged if Nate dies or gets permanently disabled. Therefore, it is a good idea to keep these loans in the federal system so that Nancy would not be responsible for them.
In a case like this, when it is difficult for a federal borrower to afford monthly payments on a standard repayment plan, it’s a good idea to see if loan forgiveness using one of the Income-Driven Repayment plans is an option. In Nate’s case, his Parent PLUS loans can become eligible for the Income-Contingent Repayment (ICR) plan if he consolidates them into one or more Direct Consolidation Loans. If Nate enrolls in ICR, he would be required to pay 20% of his discretionary income, or $709 a month. Compared to the standard 10-year plan, Nate can cut his monthly burden in half by consolidating and enrolling in ICR!
But that’s not all …
For Nate, there is another strategy worth pursuing called a double consolidation. This strategy takes at least three consolidations over several months and works in the following way:
Let’s say that Nate has 16 federal loans (one for each semester of Jack and Jill’s respective colleges). If Nate consolidates eight of his loans, he ends up with a Direct Consolidation Loan #1. If he consolidates his eight remaining loans, he ends up with Direct Consolidation Loan #2. When he consolidates the Direct Consolidation Loans #1 and #2, he ends up with a single Direct Consolidation Loan #3.
Since Direct Consolidation Loan #3 repays Direct Consolidation Loans #1 and 2, it is no longer subject to the rule restricting consolidated loans repaying Parent PLUS loans to only be eligible for ICR. Direct Consolidation Loan #3 could be eligible for some other Income-Driven Repayment plans, including IBR, PAYE or REPAYE, in which Nate would pay 10% or 15% of his discretionary income, rather than 20%.
Reducing Nate’s monthly payments
For example, if Nate qualifies for PAYE and he and Nancy file their taxes using the Married Filing Separately (MFS) status, only Nate’s $60,000 income is used to calculate his monthly payment. His monthly payment now would be reduced to $282. If he had chosen REPAYE, he would have to include Nancy’s annual income of $60,000 for the monthly payment calculation after marriage — regardless of how they file their taxes — so his payment would have been $782.
Double consolidation can be quite an arduous process, but Nate decides to do it to reduce his monthly payment from $1,443 down to $282.
How Parent PLUS borrowers can qualify for forgiveness
Since Nate is a public school teacher, he would qualify for Public Service Loan Forgiveness (PSLF), and after making 120 qualifying payments, he would get his remaining loan balance forgiven tax-free.
Since Nate is pursuing forgiveness, there is one more important thing he can do to further reduce his monthly payments. Nate can contribute more to his employer’s retirement plan. If Nate contributed $500 a month into his 403(b) plan, the amount of taxable annual income used to calculate his monthly payment is reduced, which further reduces his monthly payments to $232.
Summarizing Nate’s options in dollars and cents
- With the standard 10-year repayment plan, Nate would have to pay $1,443.26 every month for 10 years, for a total of $173,191.
- With a consolidation, enrolling in ICR, filing taxes using the Married Filing Separately status and Public Service Loan Forgiveness, he would start with $709 monthly payments and pay a total of around $99,000 in 10 years.*
- With double consolidation, enrolling in PAYE, filing taxes using the Married Filing Separately status and Public Service Loan Forgiveness, his monthly payment starts at $282, and his total for 10 years would be around $40,000.
- For maximum savings: With double consolidation, enrolling in PAYE, filing taxes using the Married Filing Separately status, Public Service Loan Forgiveness and making $500 monthly contributions to his employer retirement account for 10 years, Nate’s monthly payment starts at $232, and his total payment would be around $32,500. He would have contributed $60,000 to his 403(b) account in 10 years, which could have grown to about $86,000 with a 7% annual return. Comparing this option with the first option, we can project that Nate pays about $140,000 less in total, plus he could potentially grow his retirement savings by about $86,000.
As you can see, there are options and strategies available for parent borrowers of federal student loans. Some of the concepts applied in these strategies may work for student loans held by the students themselves as well.
An important thing to remember if you are an older borrower of federal student loans is that paying back the entire loan balance might not be the only option you have. In particular, if you qualify for an Income-Driven Repayment plan and are close to retirement, you can kill two birds with one stone by contributing as much as you can to your retirement account. Also, since federal student loans are dischargeable at death, it can be a strategic move to minimize your payments as much as possible and get them discharged at your death.
Also, loan consolidation can be beneficial as it was in this example, but if you had made qualifying payments toward loan forgiveness prior to the consolidation, you would lose all of your progress you had made toward forgiveness!
As always, every situation is unique, so if you are not sure what to do with your student loans, contact a professional with expertise in student loans.
*Note: The projections in Options 2 through 4 assume that, among other factors such as Nate’s PSLF-qualifying employment status and family size staying the same, Nate’s income grows 3% annually, which increases his monthly payment amount each year. Individual circumstances can significantly change results.
Saki Kurose is a Certified Student Loan Professional (CSLP®) and a candidate for the CFP® certification. As an associate planner at Insight Financial Strategists, she enjoys helping clients through their financial challenges. Saki is particularly passionate about working with clients with student loans to find the best repayment strategy that aligns with their goals.