Understanding Student Loan Interest Deductions: Tax Deductible is Not What You Think It Means
One of the arguments for continuing to incur student loan interest has been “oh but it’s tax deductible!”. That’s good, right? Yes and no.
I understand the need to take out student loans. I took them out myself as I went through college. My intention is not to dissuade you from them, I simply want to provide some additional details which may guide your decision on taking them out, paying them back or strategies you can use to take advantage of the tax deduction.
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When you get a tax deduction, you are lowering your taxable income but it is NOT reducing the amount of tax you owe dollar for dollar. For example, if you’re incurring $2,500 in student loan interest and you fall within the 22% tax bracket (and let’s assume that you actually do qualify to deduct the full $2,500), then you will reduce the amount of tax you owe by $550 ($2,500 x 22%). However, keep in mind you still shelled out $1,950 of interest out of your own pocket.
But wait, there’s more! Restrictions that is. The maximum you can deduct is $2,500. So if you pay $3,000 in student loan interest, you get absolutely no tax benefit for that additional $500 that you paid. There is also a phase out in effect for taxpayers with modified adjusted gross income(MAGI) between $65,000-$80,000. If your MAGI is over $65,000, then your deduction starts decreasing and once your MAGI is above $80,000 then *poof* that deduction goes away.
If you’re a recent college graduate, you may not be in the phase out range now but over time as your income grows, you’ll get to this number and boy does it suck thinking all that money you are paying towards interest is not even giving you any lick of help on your taxes.
Luckily, that MAGI number is somewhat in your control. If you can take advantage of some perks at work you can reduce your MAGI so that you can take a take a portion if not the whole deduction. If you increase your contributions into your 401k, contribute to an HSA or participate in an FSA or transit program, you may be able to drive down your MAGI enough so that it falls below the $65,000 threshold. It also doesn’t hurt to pay off those student loans sooner than the minimum repayment period required. Pay off those loans, take that $1,950, invest half and travel with the other half.
Keep this mind the next time someone tries to persuade you into doing something because “you’ll get a tax deduction”. Make sure you’re aware of the whole picture and ask or check online if there are any limitations or restrictions on taking those tax deductions. Make sure it’s worth it for you. Read the fine print dear readers.