When it comes to the student loan forgiveness plan of 2022, maximizing those potential savings might not be top of mind. However, there may be ways to turn the student loan forgiveness savings into an investment opportunity. Let’s take a look not only at the criteria for who may benefit from the recently announced student loan forgiveness plan, but also ways to turn your savings into more.
Requirements for Forgiveness
The plan will provide up to $20,000 of debt forgiveness for students who receive a Pell Grant, and $10,000 of forgiveness for non-Pell Grant recipients. (1) Pell Grants are offered to low-income and middle-income students based on financial need, and the amount awarded to students does not need to be paid back. According to the White House, approximately 60% of people who have federal student loans received Pell Grants. (2)
Borrowers are eligible for this relief if their individual income is less than $125,000 or $250,000 for households.
Private student loans are not eligible, only federal student loans. Of the $1.75 trillion of debt Americans have in student loans, roughly $1.62 trillion is from federal student loans while the remaining $131 billion comes from private loans. (3)
There is no age requirement, nor does the plan stipulate that the borrower must be the one who used the loan for college. That implies that parents, or grandparents, who took out student loans for family members would be eligible for forgiveness, so long as they met the income requirements.
The plan also stipulates that the reprieve is only for those who took out loans prior to June 30th, 2022. Thus, no loans taken after that date would be eligible for forgiveness under this plan. It is currently unclear if there will be future loan forgiveness plans.
The Department of Education said that the application to apply for forgiveness will end on Dec. 31, 2023. To be notified of when the application opens to apply, you can sign up at the Department of Education subscription page.
Additional Student Loan Changes
The plan also made changes to the repayment of federal student loans, including:
- Lowered the percentage borrowers pay of their monthly discretionary income from 10% to 5% (only for undergraduate loans).
- Forgive loan balances after 10 years of payments if the borrower has a balance of $12,000 or less.
- Paying for a borrower’s unpaid monthly interest. Some borrowers have paid their monthly payments but have seen their balances grow because of the interest. Now, as long as they make their payment, their balance will not grow.
Planning for Future College Expenses
Despite the $10,000 to $20,000 debt forgiveness coming to certain borrowers, it is still advisable to plan for other ways to pay for the cost of a college education. In 2021-2022, the average cost of an in-state public college was $10,388, while an out-of-state public college was $22,698. The average private college cost was $38,185. (4) The main takeaway is that even if there is more forgiveness, that alone won’t be able to cover the full cost of 4 years in college.
Two of the most popular ways to save for college are a 529 plan and the Coverdell Education Savings Account (ESA); each offers tax benefits and can be suitable for savers.
A 529 plan allows for borrowers to invest contributions into an account, invest it with tax-deferred growth, and withdraw the money tax-free as long as the money is used for a qualified education expense. Additionally, some states offer a tax deduction on contributions made to 529 plans.
The ESA contributions are not tax-deductible, but like a 529, your contributions grow tax-deferred, and distributions used for qualified education expenses are tax-free.
The ESA has a $2,000/year contribution limit, while there is no annual contribution limit for the 529 (although you do need to ensure you don't exceed any gift tax limits, and if you do, you’ll need to report it on your tax return).
Putting Your Savings to Work
If the student loan forgiveness plan results in your loan being paid off in full, then this is an ideal time to put that money to work for you. Instead of spending the money previously spent on monthly loan payments, consider using that money to invest and build wealth. Depending on your goals and circumstances, you can contribute to your workplace retirement plan, an IRA, or an investment account.
If you qualify but the amount forgiven will lower but not eliminate your loans, there is still plenty of good news. Not only is your loan balance lower, but the amount of interest you pay each payment will decline, which will increase how quickly you can pay off your principal.
Also, as a result of your lower loan balance, your net worth will increase, which is a key indicator of your financial health. (5)
Your Forgiven Debt May Be Taxed by Your State
For those who do have student loan debt forgiven, you will not owe any taxes on the federal level on the amount forgiven. For instance, if you receive $10,000 in debt forgiveness, you will not have to include the forgiven amount in your taxable income on your federal tax return. Additionally, most states follow that rule when it comes to your state tax returns; thus, there won’t be an additional tax owed because you qualified for forgiveness.
However, that’s not the case in every state. Currently, there are seven states where your forgiven amount would be included in your taxable income on the state level: North Carolina, Indiana, Mississippi, Arkansas, Minnesota, Wisconsin, and California. (6) While this reflects the law as it stands today, each of these states could change how forgiveness is taxed as they gather more information on the plan and make adjustments to their state's law. If you have questions about the tax implications of student loan forgiveness in your state, please contact a financial professional to get the most up-to-date information.
We Can Help
At Favor Wealth, we would like the opportunity to help you go beyond the basics of the student loan forgiveness plan and guide you on the path to building wealth. If you’d like help achieving your financial goals for many years to come, contact us at 626-529-0445 or email Ricky directly at email@example.com.
Ricky Biel is founder, wealth manager and Chartered Retirement Planning Counselor℠ professional at Favor Wealth, an independent financial advisory firm serving individuals and families near Pasadena, California. Ricky Biel founded Favor Wealth with a desire to provide unbiased, client-centered, community-based financial advice. Ricky and his team of caring, smart professionals want their clients to feel like they’ve done them a favor, making it easier than ever to accomplish their financial goals by blending proven investment methodologies with creative financial technologies. He is on a mission to help his family of clients feel both a sense of relief and excitement about their future. Favor Wealth takes care of their clients’ needs first and foremost and goes the extra mile to make their clients’ finances grow. To meet and see how the Favor Wealth team may be able to help, contact them today at 626-529-0445 or email Ricky directly at firstname.lastname@example.org.
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