Earlier this week, Reddit user ‘Red-helix‘ wondered whether he should rush to pay off his student loans. “Does it always make sense to sacrifice liquidity after college to kill those loans, when the government lets you deduct the interest without itemizing?” he asked.
We reached out to Joseph Orsolini, a certified financial planner for College Aid Planners, for his take:
“The best way to save on interest is to pay the loans off as soon as possible. Teachers may be an exception to this idea of paying loans off early because of generous loan forgiveness programs available to them.”
His reasoning is simple. A tax deduction isn’t the same as a tax credit, as it only reduces your taxable income.
For example: Say you have $50,000 of taxable income and you want to report $2,000 worth of student loan interest paid off. You’d reduce your income to $48,000. Plug this information into Turbo Tax’s online tax calculator and you’d see that without the deduction, you’d owe $6,256 and with it, you’d owe $5,756.
So, you’ve saved $500 but you’ve paid $2,000 in interest and haven’t even put a dent in your base loan yet. That’s a net loss of $1,500.
Another reason not to put off paying down student loans is that the IRS starts to cap the amount of interest you can deduct after you hit a certain salary mark. Once you make $75,000 or more you can’t deduct it at all.
“People should be mindful of the phase out limits,” says Orsolini. “Sometimes contributing to an IRA or increasing your 401k contribution to reduce your AGI can mean the difference between getting a deduction or not. If you are paying interest, it is better to get a deduction than not.”
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