Decisions about student loan repayments can significantly impact your finances long into the future, so before you jump into a consolidation loan, research your options and make sure you’re going to achieve your purpose without any costly surprises.
If you have several student loans (and many people do), you may want to consolidate them after you graduate just to simplify your record keeping and bill paying. You may also want to take advantage of the longer repayment period and lower overall payment that you may get from consolidating. Consolidating may be a good option for you if you have heavy education debt, want to lock in at a fixed rate, or want to reduce your monthly payments and are willing to pay more over the length of your loan in order to do so.
Under the Federal Direct Loan Program you can consolidate your federal student loans at a fixed interest rate with only one payment a month. The interest rate on consolidation loans is a weighted average of the interest rates on all your student loans, so you’ll basically be paying the same overall interest rate. The federal program also allows you to extend the term of the loan up to thirty years. Be aware that a longer loan period will cost you much more in interest, but there are no prepayment penalties, so you can always pay more or pay the loan off early.
Before you extend your loan repayment period, use an online calculator to calculate the true cost over time.
You can consolidate all your loans with one lender at any time without a consolidation loan if you just want to simplify your payments. If a lower interest rate is your goal, remember that after making forty-eight consecutive on-time payments, you may qualify for an interest rate reduction. This may put you at a lower rate than you could get by consolidating, depending on your current interest rate. To figure out what makes the most sense for you, try Sallie Mae’s online loan consolidation calculator in the tools and calculators section at www.salliemae.com.
You can also consider refinancing to get a better interest rate.
Up to $2,500 a year in interest on most student loans may be tax-deductible, if you meet certain criteria, such as income limits. You must have used the proceeds of the loan for qualified higher education expenses (tuition, fees, room and board, supplies, and other related expenses), and you must have been enrolled at least half-time in a qualified program at an eligible institution.
As of tax year 2019, deductibility phased out if your income was between $65,000 and $80,000 for single taxpayers and $135,000 and $165,000 for couples filing jointly. These limits are increased from time to time to adjust for inflation, so see IRS Publication 970 for up-to-date limits. Unlike the mortgage interest deduction, you don’t have to itemize in order to get this deduction. If you’re married, you have to file jointly.
If you’re starting a family of your own, you may want to consider ways to help your children pay for education. You may want to keep your children’s student loans minimal. If so, it’s never too early to look at strategies for making higher education more affordable.
One way to help children pay for college is to accumulate funds that can be used to pay for their education. You can do this in a variety of ways, but the best ways include college savings plans and certain types of retirement accounts.
Section 529 college savings plans are sponsored by each state for the purpose of helping people save for education. That education includes college, graduate school, trade school, and private K–12 schools. These plans have become popular for their tax benefits, high contribution limits, and flexibility.
You can put away a lot of money in a 529—hundreds of thousands of dollars—and the maximum contribution depends on your state laws. If you use your state’s 529 plan, you may be eligible for a state income tax deduction for your contributions. Furthermore, the earnings in the account grow tax-free, so the balance can grow more quickly. Finally, if you spend the money on qualified education expenses (which are defined quite broadly), you don’t have to pay any income tax when you take the money out. However, if you use the money for unqualified expenses, you will have to pay taxes and possibly penalties on the earnings portion of the withdrawal.
Qualified educational expenses include:
Expenses that are not qualified include:
If your child does not go to college, you can always transfer the funds toward another family member without penalty. You can even use the funds yourself—for a graduate degree, for example.
Keep in mind that if nobody uses the funds for higher education, you may have to pay taxes and penalties on any account earnings that you withdraw. The penalties may be reduced or eliminated, however, in the event that your child gets a scholarship and doesn’t need the money.
You can contribute up to $2,000 per year per beneficiary (future student) in this type of account, formerly known as an “Education IRA.” This can add up, especially if you have several children (or grandchildren), since you can contribute $2,000 annually to separate ESAs set up for each child (or grandchild). Annual contributions are allowed up until the account beneficiary turns eighteen.
If you are unmarried, your ability to make ESA contributions is phased out between adjusted gross income (AGI) of $95,000 and $110,000. For joint filers, the phaseout range is between $190,000 and $220,000. ESA earnings build up tax-free, and then the money can be withdrawn (also tax-free) to pay the account beneficiary’s K–12 school or college expenses. If withdrawals exceed eligible education expenses, the earnings portion of the withdrawal would be taxable. Like contributions to Roth IRAs (Individual Retirement Accounts that are not taxed upon distribution), ESA contributions are nondeductible, but the tax-free withdrawal privilege makes up for that. If the beneficiary doesn’t attend college, doesn’t incur enough expenses to exhaust his or her account, or is about to turn thirty, the balance can be rolled over tax-free into another family member’s ESA or into a 529 plan. If the ESA hasn’t been used or transferred by the time the beneficiary turns thirty, taxes and penalties may apply.
Eligible expenses include:
You have until April 15 of the following year to make your ESA contribution for the tax year in question. For example, you can make your 2020 ESA contribution as late as April 15, 2021.
If you think that you or your child will have to borrow to pay for education, set the stage early. Keep an eye on how assets are titled as soon as possible. Assets in your name or the child’s name can affect how your child qualifies for loans, scholarships, and gift aid. If your parents want to help their grandchild, plan ahead on how their assets can accomplish this. For example, 529 accounts can often receive favorable student aid treatment, so have Grandma and Grandpa consider 529 contributions.
If you’re self-employed and your kids are old enough to do some work, put them to work. You can pay them for tasks such as filing, stuffing envelopes, and cleaning. You’ll get a tax deduction, and they’ll have earned income that they could put into a Roth IRA. For example, the child could fund a Roth IRA, and take the contributions (but not the earnings) back out without incurring any taxes or penalties at college time. Though income or assets in the child’s name may hurt his or her chances of receiving needs-based financial aid, retirement accounts are not usually considered for this purpose.
As well, consider sending your offspring to a local community college for the first two years of his or her education. Much of those two years will be taken up with general education courses, and tuition will generally be much less than at a four-year school. The student can then transfer to a four-year college or university for the last two years of study.