A student loan RAP program may increase your payments. Tax planning can help

With a little strategy, public student loan borrowers can lower their monthly payments with the US Department of Education’s new payment plan, which comes July 1.

Under the Repayment Assistance Program, or RAP, borrowers pay a higher percentage of their income as their income grows. That means finding ways to lower your taxable income even by a small amount can lower your monthly student loan payments, says Landon Warmund, a certified financial planner and certified student loan specialist at Reliant Financial Services in Kansas City, Missouri.

“There are definitely unique opportunities with it,” said Warmund, a member of CNBC’s Financial Council.

Finding out how to reduce your monthly loan debt under the RAP could be very important to the millions of borrowers who are now being forced to leave the Biden Save for Education Value, or KEEP, program. An appeals court struck down SAVE, the most cost-effective payment system to date, earlier this year.

Student loan borrowers need to get out of SAVE within about 90 days of July 1, and many will see higher payments required under other programs.

“Borrowers can look to avoid this jump in payment by looking at what pre-tax benefits they have at work to reduce their taxable income, keeping them below key income numbers,” Warmund said.

Here’s how borrowers can try to reduce their payments under RAP.

Under RAP, monthly payments will typically range from 1% to 10% of your earnings; the more you make, the bigger your required payment. There will be a minimum monthly payment of $10 for all borrowers.

Current income-driven repayment plans, or IDRs, offer very low-income borrowers a $0 monthly payment.

RAP also does not protect a portion of the borrower’s income from the costs required in the calculation of the bill, as other IDR programs do; instead, it determines payment based on adjusted gross income. AGI is your total income before taxes, minus certain deductions.

For those who sign up for RAP, “even a one-dollar difference in AGI can lead to an impact of several hundred dollars in terms of total student loan payments over the course of a year,” Warmund said.

For example, because of the RAP formula, a student borrower with an AGI of $59,999 a year could pay about $50 a month, or $600 a year, less than a borrower with an AGI of $60,000, he said.

There are several ways borrowers can lower their AGI, and therefore lower their monthly RAP debt, says Carolina Rodriguez, director of the Education Debt Consumer Assistance Program in New York, a nonprofit that helps borrowers.

Directing a portion of your paycheck to your workplace 401(k) retirement plan or traditional IRA — or increasing your contributions to these accounts — is one option, Rodriguez says. Remember: To lower your AGI, those contributions need to be pretax or deductible, so a Roth IRA or Roth 401(k) contribution won’t help here.

If a single student borrower puts an extra $1,001 a year into a pre-tax retirement account, lowering his AGI to $69,999 from $71,000, his monthly RAP payment will drop to $350 from $414, Warmund said.

Making tax-deductible contributions to a health savings account, or HSA, or a variable spending account, or FSA, are additional options for lowering your taxable income, Rodriguez said. Companies can offer several types of FSAs, including qualified health care, dependent care and travel expenses.

Meanwhile, if you’re self-employed, claiming legitimate business expenses and deductions on your Schedule C can have the same effect, Rodriguez said.

“This can include normal and necessary business expenses, retirement income and health insurance deductibles,” she said.

Other “above the line” deductions can also lower your AGI, including the student loan interest break.

Under the RAP program, student loan borrowers can also get their monthly loan reduced by $50 for every dependent they want, Rodriguez said. Dependents are usually minor children, but can also include siblings or other relatives in certain cases, according to IRS guidelines.

That saving should be automatic and integrated with your tax filing.

“It depends on the number of dependents the borrower is claiming on their federal tax refund,” he said.

Even if you can lower your monthly payment under a RAP, you may end up paying more than you would in other plans over the life of your loan, Rodriguez said. That’s because RAP leads to student loan forgiveness only after 30 years, compared to the typical 20 or 25-year timeline for other IDR programs.

As a result, some borrowers may want to compare their monthly loan and total payment amount on RAP with other payment plans. However, RAP will be the only IDR plan available to student loan borrowers after July 1.

Borrowers with existing student loans may retain access to other current IDR programs, including the Income-Based Repayment Program, or IBR. IBR borrowers qualify for debt forgiveness after 20 or 25 years, depending on the age of their loan.

Although the Income Dependent Repayment scheme, or ICR, and the PAYE, or Pay As You Earn scheme, will also remain available to current borrowers until mid-2028, neither scheme currently leads to debt forgiveness. The only reason you want to be in any plan, is if it brings you the lowest monthly payment, Rodriguez said.

If so, you can stay on ICR or PAYE until the plans expire on July 1, 2028. After that, if you switch to IBR or RAP, you are entitled to a credit that leads to forgiveness of your previous payments.

“If RAP is going to be your lowest option, wait until it’s available,” Rodriguez said. “But remember the results of the program.”