Why does the discretionary income definition matter for student loans? It’s an arcane term and sounds as interesting as watching grass grow, but it’s actually really important. Knowing the discretionary income definition allows you to know EXACTLY what you have to pay on your student loans.
What is Discretionary Income and Why Should I Care?
The federal government created income based repayment because they want student loan payments to be affordable no matter how much you owe. How does the government figure out what an affordable payment is though? That’s where the discretionary income definition comes in.
Income based repayment programs like REPAYE, PAYE, IBR, and ICR take 10% to 20% of your “discretionary income.” That means the government needs a standardized formula to figure out what they are supposed to charge you.
Once you know how to calculate YOUR discretionary income, you’ll never need to worry or wonder what your student loan payments are going to look like ever again.
Discretionary Income Calculation Depends on Your Family Size
The discretionary income definition is a technical one, but it’s easy to understand. There are 3 steps in the calculation.
Step 1: Look up the Federal Poverty Line (FPL) for your family size
You can find these numbers by googling Federal poverty line or by checking out the numbers over at the ACA exchange. The Federal Poverty Line is the same for all of the lower 48 states. If you live in Alaska or Hawaii it’s a bit higher.
As an example, let’s pretend I’m a married father of 2 living with my family in Virginia. Check out the table below:
I find the poverty line for a family of 4 to be $25,100. If I was single with no children, then it would have been $12,140. Take a moment to find the relevant number for your family size and make a mental note of it.
Step 2: Multiply the Federal Poverty Line for Your Family Size by 150%
You know how when you’re doing your income taxes you get to deduct something from your income? The discretionary income definition is similar. You get to deduct a certain amount of money from your adjusted gross income before the government wants a percentage of it under an income driven repayment program.
Now we’ll learn how to calculate that deduction. Take the Federal Poverty Line number for your family size and multiply it by 1.5. That’s 150% of the poverty line.
Let’s look at the father in Virginia with a family size of 4. His poverty line number in 2017 was $24,600, slightly less than what it is now in 2019. Take that number from 2017 and multiply by 1.5. His deduction for the purposes of the discretionary income definition is $24,600*1.5= $36,900.
For a single person, that deduction would be $12,060*1.5= $18,090.
Step 3: Take Your Adjusted Gross Income from the Previous Tax Year and Subtract the Deduction. That’s Your Discretionary Income
Remember I said steps 1 and 2 give you the amount of income that the government won’t count in your student loan payment calculation. Here’s how the mechanics of that works.
Say the dad from Virginia has a spouse who makes $60,000 per year. He makes $100,000 and has $300,000 of law school loans. Say their combined income on the previous year tax forms shows $160,000.
To find his annual payment under Pay As You Earn and Revised Pay As You Earn, he would take $160,000 – $36,900 = $123,100 and multiply that by 10%, which equals $12,310. Divide that number by 12 to get the monthly payment required of $1,025.83.
How to Use the Discretionary Income Definition to Find Out What You’ll Pay After Graduation
Most people don’t make any income while they’re in grad school. They might have a working spouse, and if so that will influence the required payments under an income driven repayment program.
For example, let’s say Jane is a graduating med student and her husband Matt is a teacher. Matt makes $50,000 per year and Jane made $0 last year.
Using the discretionary income definition, we first look up the federal poverty line for their family size of two. That is $16,240. Now we multiple by 1.5 to get $24,360.
Take $50,000 and subtract $24,360 to get $25,640. Now multiply by 10% and divide by 12 to get a monthly payment of $213.67.
Of course, if Jane had no spouse, then her payment in the first year would’ve been $0 a month. If you wanted to know how much you’ll have to pay on student loans, download my free student loan calculator that does all the heavy lifting for you.
How Does Discretionary Income Impact IBR?
It’s largely the same math as above. Instead of multiplying the leftover amount after subtracting 150% of the federal poverty line by 10%, you multiply by 15%. That’s because IBR is 15% of your income and PAYE and REPAYE are 10% of income.
Can Discretionary Income Show my Student Loan Payment for Future Years?
It can absolutely. First, you need to know that student loan servicers use prior years’ taxable income in the calculation. So say your re-certification date for IBR is coming up this September. You graduated in mid 2016 and have been paying $0 for the past year. You’re really worried what they’re going to ask you to pay come September.
Say you worked half the year and made $60,000 (maybe you are a dentist or something like that). Take your adjusted gross income from 2016, find the poverty line number for your family size and multiply by 1.5, then subtract that from your 2016 taxable income. Multiply the result by 10% and divide by 12.
There ya go! That’s what you’ll pay for student loans when your certify in September.
How Does Discretionary Income Affect Student Loan Payments Over Time?
Great question. Discretionary income changes every year and is dependent upon taxable income, family size, and the government’s federal poverty line numbers. That means student loan payments change too every year under REPAYE/PAYE/IBR.
Here’s an example of the discretionary income over time of Jim, a veterinarian with $300,000 in student debt. He makes $65,000 and gets 5% raises each year. He’s getting married to someone with a $30,000 income and no student debt in 2019. They’re expecting 2 children to be born in 2020 and 2022. Here’s how that would look assuming a 3% growth rate in the federal poverty line.
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