The issue of student loan debt is one that seems to come up every four years during a Presidential race to see who has the best solution. Solutions are thrown around in attempts to attract millennial voters who are the biggest voting bloc suffering under the weight of student loan debt. Usually, the solutions range from student loan forgiveness to renegotiated terms of the loans. Whatever they are, they usually seem to fall to the bottom of the pile when it comes time for the elected President to get to work.
But the issue of student loan debt is not going away. Student loan debt currently totals $1.4 trillion (yes with a “T”) over 44 million borrowers. That’s more than $620 billion than total credit card debt in America. What’s worse is that it is not slowing down with the average student loan debt per graduate rose 6% from 2017 to 2018.
What should lawmakers do? Nobody wants to totally forgive a trillion dollars in debt, especially when the federal government is holding most of it (and making billions off it). But does changing interest rates from 10% to 8% make that much of a difference either?
So with all these solutions, what could possibly be a simple solution?
Make all federal student loan payments eligible for pre-tax deductions.
If you are not familiar with the idea of pre-tax deductions, they are payments you make out of your paycheck before it is hit by taxes. This is what would be called your gross income. It is all the money you earned from working before any taxes are taken out. After taxes, it is now your net income, the money left after they take money for taxes.
There are several pre-tax deductions that employees enroll in. They include 401K payments, life insurance, medical insurance, and others. You pay for these straight from your gross income when there is more money in your paycheck, thus allowing you to hold onto more money in your take-home paycheck.
Let’s take a minute to work this out to see what it looks like.
If you head over to the website Smart Asset, you can use their paycheck calculator to see how much you really bring home after taxes. So let’s play with some numbers, shall we?
Let’s say you live in San Diego and you make a respectable $80,000 as a young worker who has student loan debt from getting your undergraduate and masters degrees. If you get paid bi-weekly, your take home after taxes is around $2,200. You pay about $642 in Federal and State income taxes, and $235 in FICA (the taxes that go to fund Social Security and Medicare).
Now out of that remaining $2,200 you have lots of bills to pay including rent, utilities, gas in your car, car payments, credit card payments, and yes, student loan payments.
Let’s say hypothetically this young worker has to pay $500 a month in student loan payments (again it’s just an example I know they vary greatly).
You now have to pay this $500 from what is left over after taxes, which is a lot less than what you have before taxes.
In this scenario, a worker making $80,000 a year should have a gross income of $3,077. That is a heck of a lot more money to work with than $2,200. If you could take the $500 for the month out of your paycheck even before it is hit with taxes, then you would have more left in your pocket. Further, if the $500 is your payment for the month, you can split that up in two payments of $250 per paycheck.
Still not convinced? How about we dive into some math for additional examples.
Example 1: Student Loan Payments After Taxes
Net income for the month: $4,400 — (Rent $2,000) — (Utilities $50) — (Food $200) — (Credit Card Payments $100) — (Car Payment $250) — (Student Loan Payment $500) = $1,300
Still not bad to have that much left over, but it’s never this easy in life. You have to factor in other things you pay for. Things come up, you want to travel, etc. I mean you worked hard to get where you are, don’t you want to enjoy that money?
Let’s try it with this solution to see the difference.
Example 2: Student Loan Payments Before Taxes
If you add student loans as a pre-tax deduction like a 401K payment, your bi-weekly take-home pay would be $2,030. Less than above, but stay with me for a moment.
Net income for the month: $4,060 — (Rent $2,000) — (Utilities $50) — (Food $200) — (Credit Card Payments $100) — (Car Payment $250) = $1,460.
Remember you already paid your student loan payments out of your gross pay rather than your net take-home pay.
But someone might look at this and say “So what that’s $160 per month, big deal.”
That $160 saving equals $1,920 a year.
Over the course of repayment for a student loan (20 years) that’s $38,400.
If you have a student loan with the federal government that equals $120,000 and you pay the minimum $500 you will pay it off in 20 years. If you take the extra money you now have saved because of this pre-tax deduction, you can now pay it off in 15 years. Saving you 5 years of loan repayment.
Or, you can just…spend it. It’s your money! You can do whatever you want with it. The sky is the limit.
But that’s not the only benefit of this small change.
What Else Can You Change to Make It Easier?
Currently, you can deduct the amount of interest you paid on student loans from your year-end taxes up to $2,500. However, there is a caveat (as there always is with taxes), it’s only good for certain income levels. That means the hypothetical young worker in our scenario would not be able to deduct this from their taxes because if you make $80,000 or more you are not qualified.
My suggestion is to eliminate the income level restrictions on the deductions. Or if that sounds too harsh for people who think people who earn more should pay their “fair share”, why not make it that the deduction is only applicable as a one-time payment towards your total debt if you are set for a tax refund.
For example, if you filed your taxes, and deducted student loan interest to bring your total refund up to $8,000, then $2,500 would be automatically deducted and applied to your federal student loan debt. Instead of issuing you a check for $8,000, the government can send you a check for $5,500 and send the $2,500 over to the Department of Education to pay your student loan bill.
Over 20 years, that is an additional $50,000 paid toward your student loan debt. Combine that with the extra $38,400 and you will be able to pay off $120,000 in…hold your breath…5 years.
See how fast this all adds up?
Why Only Federal Student Loans?
During President Obama’s administration, he consolidated all student loans under the federal government to stop the predatory nature of private lenders such as Sallie Mae from saddling students with enormous private debt.
The argument was that in doing so, the federal government was helping students by eliminating the private lenders.
While there are many protections in place to help students who borrowed from the government (Income Based Repayment is probably the biggest), the end result is the same. The federal government makes money off of these loans. I would be shocked to find any student loan borrower who will stand up in defense of the federal government and argue that they should make billions of dollars off of students.
Further, it is much easier to have the federal government change their own rules than to try and force private companies to abide by rules. The lobbying on behalf of private companies would be intense to keep it status quo for fear they would lose out on precious interest payments.
But, if the willpower is there to allow for payments to private companies as well, then great, go for it. I am looking for easy solutions that would tweak tax laws here and there to give immediate relief to students.
But What’s the Long-Term Effect of This?
I am not going to sit here and pretend I am any sort of tax or policy expert who can muster up some CBO style report on what would likely happen. What I can tell you is the federal government will lose some money on this deal from fewer interest payments if students pay off debt faster. They won’t lose any money from income taxes because you still pay the same amount, it’s just your student loan payment comes from your gross income.
But with an average default rate of 11% by borrowers. The government is losing money anyway when people don’t pay. As a lender, isn’t it in your best interests to have people pay you back the billions of dollars you lent out rather than them go bust?
How about that little pay raise of $160? If we use it as a simple example, there are 44 million borrowers out there, and if they all got a $160 bonus in their paycheck every month, that would equal about $7 billion each month that is added into the economy. That’s $84 billion a year, and over the course of one student loan repayment timeline, that’s $1.6 trillion, which is more than the total outstanding student loan debt.
Imagine what adding $7 billion each month to the economy would do? Young workers can spend and improve the economy, save it for a rainy day, maybe save it for a down payment on a house. Instead of spending money we don’t have, this would be an economic stimulus of massive proportions and all it would take is a small fix in the tax code.
Student loan debt is the giant, smelly 800-pound gorilla in the room for many young workers. It will not go away overnight, and to be honest, it will continue to be used so it will always be around.
Student loans do provide a valuable service to many young Americans. It has helped elevate many young Americans into good paying jobs and into the middle and upper classes of society. It does have a valuable purpose.
But, it doesn’t change the fact that at the end of the day, someone borrowed from someone else, and they need to be paid back. There will be hard work on both sides to make it work. Both sides are going to have to put some skin in the game to make it work.
And not all workers will diligently use that extra money to pay down debt faster. But that is the point. This is your money. Instead of deciding between getting your car fixed or paying your student loan payment each month, you have the freedom to use that money how you like. Either way, whether you pay down student loan debt or you put it back into the economy, the federal government wins.
In the end, young workers pay off their student loans while also getting a raise, student loan debt can be paid down faster, the economy can grow, and a whole generation can be freed from the oppressive weight of student loan debt.
All it takes is one simple little solution.