Discretionary income is a term that is used a lot in regards to student loans. It’s used when calculating student loan payments under all of the income driven repayment plans. It’s also something that changes annually based on certain factors both within and outside of the borrowers control. It is important to understand what is discretionary income, how it’s calculated, and how its applied to your student loan payments.
What exactly is discretionary Income?
Discretionary income is the amount of income remaining after deduction of taxes, other mandatory charges, and expenditures on necessary items. It’s essentially the income you have left over after paying all necessary and required living expenses. It does not account for personal items such as electronics, vacations, or various shopping someone might do. Discretionary income doesn’t include things like available credit limits or loans, it only looks at your actual income. For the purpose of student loans, discretionary income is your adjusted gross income on your tax returns subtracted by 150% of the poverty guideline for your family size.
What is the poverty guideline?
Every year the government releases a poverty guideline for the 48 contiguous states, and individually for the states of Alaska and Hawaii. Alaska and Hawaii have a higher cost of living so their guideline is individualized. The guideline is calculated by using the most recent census data and then adjusting for inflation against the annual Consumer Price Index (CPI) for annual updates. The poverty guideline is not supposed to be a cost of living. It’s literally the income that is considered to be living in poverty.
How to figure out your discretionary income
Your discretionary income is simply your adjusted gross income found on your most recent tax return(line 37 on form 1040) minus 150% of the poverty guideline for your family size. To calculate your discretionary income, you need to know a few things.
• Your adjusted gross income as reported on your taxes
• Your family size as reported on your taxes
• The poverty guideline for your state.
When you have all these, the calculation is easy. It’s simply your income subtracted by 150% of the poverty guideline for your state and family size. Here is a chart which shows the 150% poverty guideline for various family sizes
150% of the poverty guideline for 2017:
|Family Size||48 Contiguous||Alaska||Hawaii|
*For family member over 8, add $4,180 for the 48 contiguous, $5,230 for Alaska, and $4,810 for Hawaii
Now, using the table above we can see that depending on which state you live in, and how big your family size is, the poverty guideline will change. These numbers will slowly rise every year as the guideline is adjusted according to the CPI. This would mean that theoretically if your family size doesn’t change and your income doesn’t change, your student loan payment should be a bit smaller on an annual basis. We will discuss this in more detail a little bit further down the page.
Discretionary income based on family size and adjusted gross income (AGI) for the 48 contiguous states:
|Family Size||$30,000 AGI||$45,000 AGI||$60,000 AGI|
How discretionary income is connected to student loan payments
If you have federal student loans, you should know that there are multiple repayment plans available to most borrowers, many of which are calculated using your discretionary income. The goal of these repayment plans is to reduce the number of defaulted student loans and make payments more affordable. When the student loan payment takes into account a person’s income, family size, and necessary expenses, it’s a more customized payment depending on each individuals circumstance. To calculate your annual student loan payment in any of the income driven repayment plans, simply take your discretionary income and multiply it by the percentage used for your repayment payment plan. For example, if your discretionary income is $14,370, your annual payment in the REPAYE would be $1,437. Divide that by 12 to get your monthly payment or $119.75 in this case. If you were not in the REPAYE and in the IBR, we would use 15% of your discretionary income of $14,370 as a payment, which would equate to $2,155.50 annually or $179.63 per month.
Here is a table showing each repayment plan that takes into account discretionary income, and what percentage of that income is used to calculate the annual student loan payment
Discretionary Income Will Change Annually
Discretionary income can and will change annually, which is why all the income driven repayment plans require an annual recertification of your income. Discretionary income will change as the poverty guideline changes annually to adjust for the CPI, which will impact your payment. Also, as your income changes, so will your discretionary income. And lastly, when your family size changes your discretionary income will change. This confuses many borrowers when they unexpectedly have a new payment amount in the following year. It’s extremely important to remember to recertify your income annually or your servicer will place you into a standard repayment plan, likely increasing your payment as well as losing some forgiveness benefits.
Understanding the various terms in regards to your student loans is critical. Knowing how to calculate your discretionary income, and how it may change annually will allow you to know exactly what you should be paying on your student loans, as well as predicting future payments in upcoming years. If you know the repayment plan type you are in and what percentage of your discretionary income is used to calculate your payment, you should never be surprised by your student loan payment and make sure that no errors have occurred on the servicing side to cause you to pay more than you must be paying by law.