How to Reduce Your AGI to Get the Most from Income Based Repayment
July 8, 2013

The income sensitive repayment plans offered by the federal government for public student loans are based around your family size and your Adjusted Gross Income – otherwise known as AGI. This is a very important number and the lower you can whittle it down, the more modest your monthly payments will be. Income Based Repayment (IBR), Income Contingent Repayment (ICR) and Pay As You Earn (PAYE) are all predicated on this all-important number.

To apply for any of these programs, you must submit information on your adjusted gross income, family size and loan information (balance, interest rate, etc). There are then pre-set formulas – usually on a sliding scale – that determine eligibility and how much your monthly payments will be. In many cases, payments offered can be as low as $0! Check out the following info on AGI to get the lowest possible repayment scenario for your loans.

What Is Adjusted Gross Income (AGI)? The IRS defines AGI as “gross income minus adjustments to income.” That’s not very specific though, is it? Okay let’s try this way. It’s the income you’ve earned plus any distributions made that qualify as income minus certain amounts that are considered adjustments to income rather than deductions. See on the image below the roster of adjustments that are allowed. Click here for a simple AGI calculator offered by CNN Money. Below are listed some ways you can legally decrease your AGI to make your student loan payments more affordable under the income sensitive plans mentioned above.

#1 Increase Contributions to Your Health Spending Accounts These are those nifty little accounts your employer offers each year where you can sock away pre-tax dollars (i.e. money that’s not subject to FICA or income taxes) that can be used to pay out of pocket medical costs, co-pays and some over the counter medicine costs. The new annual cap for 2013 is $2,500. That’s roughly $208 per month.

If you routinely take medication, have Rx or doctor visit co-pays, these can be paid or reimbursed from this account. Contact lenses, eyeglasses, medical and dental copays, coinsurance percentages or fees, band-aids, vitamins, over-the-counter medicines, orthodontia and more are all covered. If you’d be spending anyway out of necessity, it’s wiser to use an HSA so that you reap the tax benefit as well as the benefit of having a lower AGI for income-based repayment consideration.

#2 Increase Contributions to Retirement Contributions to 401(k) plans and Traditional IRAs can both be made with pre-tax dollars. This means that you’ll be lowering your AGI by tucking away money for your retirement. If you are eligible for a tax-free forgiveness program such as teacher, nursing, military or other public service loan forgiveness (PSLF), you want to minimize your AGI so you’ll pay in the least amount prior to your forgiveness threshold.

Amping up your retirement contribution not only benefits you in the short-run (particularly if you’re a PSLF candidate) but also in the long-run when you’ve got plenty socked away for retirement. If you don’t qualify for PSLF and are looking toward 20-25 year loan forgiveness, you need to balance out the tax implications of the forgiveness benefit versus how much you’ll accrue in matching funds and interest earned over that same period to weigh the cost-benefit.

#3 Be Mindful of Student Loan Interest Paid This may sound like a circular reference, but the more you pay in student loan interest, the lower your AGI will be and the lower your income-sensitive repayment amount will be. Interest becomes a concern if you are not eligible for tax-free student loan forgiveness and here’s why. If you don’t pay off at least the monthly amount of accrued interest, you will be hit by interest capitalization where interest piles on top of interest to accrue even more interest!

But if you service at least the amount of interest due each month (even if this is in excess of the amount IBR/ICR/PAYE determines you must pay) you won’t be facing a huge tax bill if your forgiveness is taxable and the balance has grown. For instance, if your IBR payment is set at $70 and your loan accrues $150 in interest each month, you’ll have $80 left over that then starts to accrue interest as well. This is a balancing act for those not eligible for PSLF. For those planning on PSLF, pay the low payments, include the interest on your AGI determination and enjoy the lowered payments!

Final Thoughts There’s a cost-benefit to every financial decision you make. If you can afford to pay your loans under the 10 year standard plan, you should do that. Even better, you should apply the debt avalanche mindset and try to pay it off even sooner. But if you’re too broke to pay your loans under the decade plan, adopt an income-sensitive plan and then still pile on any extra monies you have and ask that these funds be applied towards accrued monthly interest and then principal for any additional amounts! This will minimize the tax hit if you have to ride an income sensitive plan all the way out to forgiveness in 20-25 years.

To get a better grip on your student loans, click here to try’s free student loan management tool. You can see all your loans in one easy to understand interface, see how your monthly obligations would change under various repayment plans and contact your lenders for assistance. Also please check out these recent blog posts on how to deal with your debt:

Student Loan Repayment Series – Part I – Married with Kids and Student Loans

Student Loan Repayment Series – Part II – Single with High Debt and Low Income

Student Loan Repayment Series – Part III – Married Soldier with Student Loans

Student Loan Repayment Series – Part IV – Divorced with Debt