Planning a wedding doesn’t leave much time to consider how marriage will impact your finances. But there’s more to it than “what’s mine is yours and what’s yours is mine.” If you have student loans and are on an income-driven repayment plan, marriage can have a big impact on your student loan repayment.
Several of the most beneficial student loan forgiveness programs — Public Service Loan forgiveness (PSLF) and Income Driven Repayment (IDR) forgiveness — require you be on an income-driven repayment plan. The monthly student loan payment calculated by these income-driven repayment plans are all based off your Adjusted Gross Income (AGI). Once you are married and begin filing a tax return jointly with your spouse, your AGI will include their income as well as yours.
How to calculate income-driven repayment
Here’s the formula for how income-driven repayment is calculated:
((AGI – (percentage * Federal Poverty Line Income)) * discretionary income percentage) /12 = monthly payment
Both percentages noted above are determined by which specific income-driven repayment plan you are on. There are four main plans available.
For example, say you are single with no dependents working in a fellowship making $75,000 per year. You are going for PSLF and are on the Pay As You Earn (PAYE) repayment plan. Your monthly payment, based off of a $75,000 AGI for 2020, would be as follows:
(($75,000 – (150% * $12,760)) * 10%) /12 = $466/month
But now you are getting married to someone making $50,000 per year with no student loans and no dependents. If you file married filing joint, your incomes will both be added to your AGI, making it $125,000 per year and increasing your monthly student loan payment. Since you are now a family size of two, your federal poverty line income subtracted from your AGI will increase.
(($125,000 – (150% * $17,240)) * 10%) /12 = $826/month
Higher income often results in higher monthly student loan payments, which ultimately leads to more paid before your loans are forgiven if you’re aiming for PSLF or IDR forgiveness.
How your tax return filing type impacts your available strategies
There are tax-planning strategies you should consider using to help keep your monthly loan payments low. However, the benefits of certain strategies change depending on whether you live in a non-community property state or a community property state.
Non-community property states: One available strategy is filing your tax return married filing separate (MFS). If you live in a non-community property state, this strategy can help keep your spouse’s income separate from yours, resulting in lower reported income and lower monthly payments on your student loans.
Let’s take the example above where the individual’s loan payment went from $466 per month to $826 per month once they got married and filed jointly. If they decided to file their tax return separately, payments would stay at $466 per month since the spouse’s $50,000 income would be on a separate return. That is an annual savings of roughly $4,320 on student loan payments.
There are trade-offs to filing your tax return married filing separate rather than married filing joint. These include losing the current federal income tax student loan interest deduction and dependent care credit, along with some state income tax credits or deductions.
Additionally, MFS can impact your retirement savings. Eligibility to contribute to a Roth IRA is limited or eliminated for taxpayers using this filing status. Likewise, while you’ll be able to contribute to a traditional IRA under MFS, your ability to receive a tax deduction for those contributions may be limited or eliminated. The good news is that MFS filing status does not change your eligibility for contributing to a qualified employer retirement plan, such as a 401(k) or 403(b).
Community property states: Filing your tax return MFS has a different impact if you live in one of the nine community property states.1 In community property states, all income is assigned equally to the two spouses. If you file your tax return MFS in these states, you are effectively electing for your combined incomes to be split 50/50.
To illustrate how this works, let’s assume you earn $75,000 and your spouse earns $50,000. If you file your taxes MFS in a community property state, each of your returns would show $62,500 of income (($75,000+$50,000)/2). This allows you to shift some of your income over to your spouse, lowering your student loan payments compared to when you were filing a single return.
Doing this would result in your payments going from $826 per month if filing jointly to about $305 per month filing separately. That is a savings of $6,252 a year.
This strategy works well when the student loan borrower who is aiming for forgiveness is the higher income earner. Let’s use the example of a physician who has completed residency and fellowship and is now earning $250,000 a year. The physician is in the process of aiming for PSLF, and their spouse is still a student in a graduate program, making no income. This strategy could result in the physician moving over half of their income to their spouse, creating a MFS return that reports $125,000 of income instead of $250,000. That would result in a big decrease in monthly student loan payment for the physician.
Should you leverage the married filing separately strategy?
To better understand whether you could benefit from a MFS filing strategy, you should work with a skilled tax advisor who has experience in individual tax planning. There is an additional cost to filing MFS, as your tax advisor will need to file two returns rather than one — one for you and one for your spouse. That’s why it’s important to consult your tax professional about your options before making any decisions. If the student loan savings outweigh the additional tax costs, this could be a very helpful strategy for your student loan repayment.
These are only some of the strategies to consider for your student loan repayment once married. For more information about strategies like this and how they could help you, please reach out to a Wipfli Financial advisor to start the conversation.