Paying Under IBR for Federal Student Loans? Get Ready for a Big Tax Bill

Income based repayment is a payment plan for federal student loan borrowers that caps a borrowers monthly loan obligation anywhere from 10% to 15% of monthly discretionary income. You make these payments for 20 years, and after successful completetion of this program, all your remaining student loan debt is forgiven.  There’s one catch – any “forgiven” income at the end of the 20 years is counted as income for tax purposes. So toward the end of your career, you could wind up with a very large tax obligation where there are no IBR options.

This is a short but necessary nugget of information that many people are unaware of when they sign up for the income based repayment plan for their federal student loans. To top it off, many borrowers’ monthly payments aren’t even enough to cover interest, so at the end of 20 years, their original principal balance could have doubled.  For instance, if you have a borrower with a $30,000 prinicipal balance who is only paying $50/month under the IBR program, the accrued interest will continually capitalize and result in a balance over double of what they started with.  If that approximately $70,000 balance is forgiven, that borrower can look forward to a nice tax bill at the end of his or her career.

This is not to say that IBR is a bad option, but it’s something that every borrower should be aware of. There really are no free lunches.

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