By Michael Donahoe, CFP®
President Biden recently announced a plan to forgive student loans for qualified borrowers. As with any new government program, there are many questions as to who qualifies and how much will be forgiven.
The plan would 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)
Requirements for Forgiveness
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 means 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 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).
If You Qualify for Forgiveness
If you qualify and your new student loan balance will be fully paid off, this is a great time to take the next step in your financial life. Instead of immediately spending the money previously contributed to student loans, 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 a joint 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)
We Can Help
The full details of the student loan forgiveness program should be released soon. In the meantime, Harvest Asset Group can help you prepare and also discuss savings strategies that may benefit you. Reach out today by calling us at (207) 775-1151 or emailing email@example.com. You can also get access to our best financial insights and tips by signing up for our valued-packed newsletter.
Michael Donahoe is the founder and principal of Harvest Asset Group, LLC, an independent, fee-only financial planning and investment management advisory firm in Portland, Maine. Michael enjoyed a successful corporate career in marketing and sales before transitioning to the financial planning profession, founding his firm in 2012, where he now leads the client services team and serves as the firm’s chief compliance officer. Michael earned his MBA degree from George Washington University and completed his educational requirements to earn the CFP® mark of distinction at the University of California, Berkeley. He is a Fee-Only and NAPFA registered financial advisor, a designation which followed the completion of rigorous continuing education requirements. Michael has lived in the Portland area since relocating from San Francisco in 1995 to be closer to family. He is active in community affairs and spends his non-working time enjoying the natural beauty of Maine.