How Adjusted Gross Income Impacts Your Student Loan Payments

Your adjusted gross income (AGI) plays a major role in determining your federal student loan payments if you are on an income-driven repayment (IDR) plan. Understanding what AGI is how it’s calculated and strategies to reduce it can help you lower your monthly student loan bills.

What is Adjusted Gross Income?

Adjusted gross income is your total income from all sources minus certain adjustments to income allowed by the IRS. It includes:

• Wages, salaries, tips
• Interest and dividend income
• Business income
• Retirement distributions
• Capital gains
• Unemployment compensation
• Alimony received

AGI does not include child support payments received,

Some of the most common adjustments, also called “above-the-line” deductions, that can lower your AGI include:

• Educator expenses
• Student loan interest deduction
• Certain business expenses
• Health savings account contributions
• Moving expenses
• Self-employment taxes
• Retirement plan contributions
• Alimony paid
• Penalty on early withdrawal of savings

Your AGI is calculated as:

Total Income – Above-the-Line Deductions = Adjusted Gross Income

So the lower your AGI, the less income tax you’ll owe and the lower your student loan payment could be if you are on an IDR plan.

How AGI Affects IDR Payments

There are four income-driven repayment plans offered by the Department of Education:

• REPAYE
• PAYE
• IBR
• ICR

While the details of each IDR plan vary, they all determine your monthly payment based on your AGI, family size, and poverty guidelines set each year by the Federal government.

Here’s a quick overview of how it works:

• Your discretionary income is calculated by taking your AGI and subtracting a certain percentage of the poverty line based on your family size.
• Your discretionary income amount is then multiplied by a percentage set by each repayment plan. This result is your annual payment.
• The annual payment is divided by 12 to calculate your monthly student loan payment.

Clearly, the lower your AGI, the lower your discretionary income, and in turn the lower your monthly student loan payment will be.

For example, let’s say your AGI is $50,000 as a family of three. Under the REPAYE plan, your discretionary income would be $32,920 (AGI minus 250% of the 2023 poverty line for a family of three).

With a 10% multiplier, your annual payment would be $3,292, or around $275 per month.

But if you reduced your AGI to $40,000 through deductions, your new discretionary income would be $23,760. Your annual payment drops to $2,376, or $198 per month – a significant reduction just by lowering your AGI.

Strategies to Reduce AGI for Student Loans

The best ways to lower your AGI all involve utilizing above-the-line tax deductions to your full advantage. Here are some key strategies to consider:

Max Out Retirement Contributions

Making pre-tax contributions to a 401(k), 403(b), SIMPLE IRA, or other workplace retirement plan can directly lower your AGI.

For 2023, you can contribute up to $22,500 total across these accounts. If your employer offers matching contributions, be sure to contribute enough to get the full match.

You can also contribute up to $6,500 to a traditional IRA in 2023, which can further reduce your AGI if you meet eligibility requirements. Your spouse can do the same to double the tax benefits.

Health Savings Account Contributions

If you have a qualifying high deductible health plan, contributing to a health savings account (HSA) can provide a triple tax benefit:

1. Contributions are tax-deductible and lower your AGI
2. Growth is tax-deferred
3. Withdrawals for medical expenses are tax-free

In 2023, you can contribute up to $3,850 for individual coverage or $7,750 for family coverage in an HSA. Be sure to maximize this often overlooked deduction.

Student Loan Interest Deduction

Paying interest on your student loans can generate an above-the-line deduction up to $2,500 per year. There are modified AGI limits to qualify, but this deduction can put extra money back in your pocket.

Business, Moving, and Other Deductions

If you are self-employed or have certain unreimbursed employee business expenses, these can reduce your AGI as well. Also look into moving expenses for a new job and alimony paid to an ex-spouse.

Every deduction helps maximize your student loan interest and retirement contributions too.

Tips for Reducing AGI

Here are some additional tips when it comes to reducing your AGI:

• If married, consider filing taxes separately if it results in a lower AGI for you. This could benefit your IDR payment.

• Avoid tapping retirement accounts or realizing capital gains if possible, as this increases your income.

• If you have kids in college, see if you can claim them as dependents if they are not filing their own return, as this increases family size for IDR.

• Consider tax-loss harvesting investment losses to offset any capital gains.

• Bunch itemized deductions like charitable contributions and property taxes in one year if possible and take the standard deduction in other years.

• Contribute to an FSA for dependent or health care costs. This reduces taxable income.

• Talk to your CPA about setting up a S-corp or LLC taxed as an S-corp to reduce your self-employment taxes.

Plan Ahead for Student Loan Payments

Your goal is to make your AGI as low as possible through legal above-the-line deductions so that your monthly student loan payment is reduced. This puts more money back in your pocket while pursuing Public Service Loan Forgiveness or getting your loans forgiven under IDR at the end of your repayment term.

Be sure to re-certify your IDR plan each year to recalculate your new payment. Work closely with a tax professional to minimize your AGI and maximize deductions. Follow these steps and you can end up with lower student loan bills.