What is Discretionary Income?
Discretionary income refers to the portion of your income that remains after paying for essential expenses. In everyday terms, it's the money you have left over for non-essential spending like entertainment, hobbies, and savings after covering necessities such as housing, food, utilities, and taxes.
However, in the context of federal student loans, discretionary income has a very specific and technical definition established by the U.S. Department of Education. This definition directly affects how much you pay under income-driven repayment (IDR) plans.
General vs. Federal Student Loan Definition
It's crucial to understand the difference:
- General Definition: Income minus all essential expenses (rent, food, utilities, etc.)
- Federal Student Loan Definition: Adjusted Gross Income (AGI) minus a percentage of the federal poverty guideline for your family size
The federal definition is standardized to ensure consistent treatment across all borrowers, regardless of their actual living expenses or geographic location (with minor adjustments for Alaska and Hawaii).
Discretionary Income and Student Loans
When you enroll in an income-driven repayment plan, your monthly payment is calculated as a percentage of your discretionary income. This ensures that borrowers with lower incomes relative to their family size pay less than those with higher incomes.
The multiplier varies by plan:
- 150% - Used by most IDR plans (IBR, PAYE, traditional REPAYE)
- 225% - Used by the new SAVE plan
How to Calculate Discretionary Income
Follow these steps to calculate your discretionary income for student loan purposes:
- Determine Your AGI: Find your Adjusted Gross Income on your most recent tax return (Line 11 on Form 1040)
- Identify Your Family Size: Count yourself, your spouse (if married), and any dependents
- Find the Poverty Guideline: Look up the federal poverty guideline for your family size and location
- Apply the Multiplier: Multiply the poverty guideline by the appropriate percentage (150% or 225%)
- Calculate the Difference: Subtract the adjusted poverty line from your AGI
Example Calculation
Given:
- Annual Income: $50,000
- Family Size: 2 people
- Location: Contiguous U.S.
- 2024 Poverty Guideline for 2 people: $20,440
- Multiplier: 150%
Calculation:
Adjusted Poverty Line = $20,440 × 1.5 = $30,660
Discretionary Income = $50,000 - $30,660 = $19,340
Monthly Payment (10%) = $19,340 × 0.10 ÷ 12 = $161.17/month
Federal Poverty Guidelines Explained
The federal poverty guidelines are updated annually by the Department of Health and Human Services (HHS). They are used to determine eligibility for various federal programs and serve as the basis for calculating discretionary income for student loans.
Key points about poverty guidelines:
- Updated each January and published in the Federal Register
- Separate guidelines exist for the 48 contiguous states/D.C., Alaska, and Hawaii
- Alaska guidelines are approximately 25% higher than the contiguous states
- Hawaii guidelines are approximately 15% higher than the contiguous states
- Each additional family member adds approximately $5,140 to the guideline (varies by location)
Income-Driven Repayment Plans
Several income-driven repayment plans are available for federal student loan borrowers:
Income-Based Repayment (IBR)
- Payment: 10-15% of discretionary income
- Poverty multiplier: 150%
- Forgiveness: After 20-25 years of qualifying payments
- Eligibility: Partial financial hardship required
Pay As You Earn (PAYE)
- Payment: 10% of discretionary income
- Poverty multiplier: 150%
- Forgiveness: After 20 years of qualifying payments
- Eligibility: Must be a new borrower as of specific dates
Income-Contingent Repayment (ICR)
- Payment: 20% of discretionary income OR fixed 12-year payment, whichever is less
- Forgiveness: After 25 years of qualifying payments
- Eligibility: Only IDR plan available for Parent PLUS loans (via consolidation)
The SAVE Plan
The SAVE Plan (Saving on a Valuable Education) is the newest income-driven repayment option, replacing the REPAYE plan with more generous terms:
- Higher Protection: Uses 225% of the poverty line (vs. 150%)
- Lower Payments: 5% for undergraduate loans, 10% for graduate loans
- No Interest Capitalization: Unpaid interest doesn't get added to principal
- Spousal Income: Spouse's income only included if filing jointly
- Faster Forgiveness: Potential forgiveness after 10 years for small balances
Tips for Managing Student Loans
- Recertify Annually: Income-driven plans require annual recertification of your income and family size
- Report Family Changes: If your family size increases, notify your servicer to potentially lower payments
- Consider Filing Status: For some plans, filing taxes separately from your spouse may reduce payments
- Track Qualifying Payments: Keep records of all payments for loan forgiveness programs
- Review Plan Options: Compare different IDR plans annually to find the best fit
Frequently Asked Questions
What if my discretionary income is negative?
If your AGI is below the adjusted poverty line (resulting in negative discretionary income), your payment under IDR plans would be $0. You would still need to recertify annually, and these $0 payments typically count toward forgiveness.
Does my state affect the calculation?
Only if you live in Alaska or Hawaii, which have higher poverty guidelines. All other states use the same poverty guideline amounts.
How often do poverty guidelines change?
Poverty guidelines are updated annually, typically published in January. The new guidelines generally increase each year to account for inflation.
Can I switch between IDR plans?
Yes, you can generally switch between income-driven repayment plans at any time by contacting your loan servicer. However, some plans have specific eligibility requirements.
What counts as family size?
Family size includes yourself, your spouse (regardless of how you file taxes), and any children or other dependents who receive more than half their support from you.