Calculating your discretionary income may feel like you are stuck in tax time again, but once everything is explained it is quite simple to figure out. First, before we can take you right into the numbers, there is a couple areas leading up to discretionary income calculations which need to be defined in order to understand the complete process.
The 150% Poverty guideline
There is a minimum income that defines “poverty” Below is a chart based on info from the U.S. Department of Health and Human Services for the 48 contiguous states HI and AK not included. For each household size, there is a minimum income designated as the poverty guideline.
The federal poverty level changes each year and is based upon your family size. For 2015, the numbers look like this:
150% of Poverty Level
What exactly is discretionary income for student loans? For the purpose of your student loan payments, discretionary income is every pre-tax dollar you make above the numbers listed on the table below. Let’s say your household size is 4 and your income is $50,000 per year. On the table it lists a household of 4 at 150% poverty level total is $36,375. Subtract the $36,375 from the $ 50,000 to get a discretionary income of $14,375.
Before you are set to repay your student loans under IBR or PAYE programs the government allows you keep 100% of your salary up to a certain point. That number is set at 150% of the poverty level. According to the Department of Education, this is the portion of your income that is non-discretionary.
If you are getting ready to begin repayment on federal student loans, be aware there are options available for a payment plan.
If your payments are too high relative to income, falling below the established number on the federal poverty level chart, you may qualify for reduced payments with the Income Based Repayment plan. The program caps monthly payments at 15% of discretionary income.
What is an AGI?
AGI means “Adjusted Gross Income” which is your total income minus any reductions (such as personal exemptions and itemized deductions).
The way to find your adjusted gross income (AGI) is by looking on your tax return.
- Form 1040: line 27
- Form 1040A: line 21
- Form 1040EZ: line 4
The exact amount will vary depending on which method you use to verify your income with your lender. Some borrowers will two of their most recent pay stubs and others will use last year’s taxes. If you use your most recent tax form, it will be based upon your AGI.
Again, Calculate Your Discretionary Income:
The equation can be done like this: Adjusted Gross Income – Household Poverty Level @ (150%)
Example: Let’s say you graduated and end up with $120,000 in student loan debt. Your income from employment is earning $49,651 per year. You filed taxes as single and as the only person in your household. On the standard 10-year term repayment plan your payments would be about $1,380 a month. Let’s break down the important numbers.
Your annual income: $49,651, a Monthly AGI of $4,138.
1 person household Poverty Level @ 150% = $16,755, a monthly amount of $1,396.
- $4,138 – $1,396 = $2,742 Discretionary monthly income
- Multiply your discretionary monthly income by your IBR payment: 15% of discretionary income
- $2,742 discretionary income x .15 = $411 estimated monthly IBR payment
If you have federal student loans the two best repayment plans are Income-Based Repayment (IBR) which is 15 % of discretionary income and Pay As You Earn (PAYE) is reduced to 10% of your discretionary income. These repayment plans are preferred because your student loan payment is based upon what you can afford rather than how much you owe. For most borrowers this helps immensely with a big reduction in minimum monthly payments.
Your discretionary income
If you have other financial obligations such as child support, medical bills, legal bills, or even private loans, your discretionary income does not change. What you can afford to realistically pay is not a consideration when going by the Federal Poverty guidelines. Many borrowers simply have other financial, emergency, or unique ongoing circumstances which are not considered. If you are smart, you will try to find a way to lower your AGI, and reduce your discretionary income to get a lower IBR or PAYE payment. But remember, the interest will still be accruing.