College Game Plan

This tax break isn't much of a windfall for student loan borrowers

Key Points
  • You can deduct a maximum of $2,500 in student loan interest.
  • What you can save is based on how much you earn.
Tuition-free college could be a reality

If you're sitting on a huge pile of student debt and think your loan interest deduction will save you loads on taxes, think again.

That because borrowers are permitted to deduct only a portion of the interest they've paid on educational debt. And it phases out if you make too much.

As long as you've paid at least $600 in student loan interest you will get a Form 1098-E from your lender or the firm servicing your debt that you can use to claim the deduction at tax time.

The trouble is the benefits aren't as widespread as borrowers may believe — and they aren't very helpful if you have a lot of debt or are earning too much money.

"You get these forms from your lender, and then you find out you can't deduct the interest," said Gavin Morrissey, managing partner at Financial Strategy Associates in Needham, Massachusetts. "That happens with a lot of people."

Here's why the student loan interest deduction is less of a "give-me" than you think it is.

How it works

The student loan interest deduction allows you to lower your taxable income by up to $2,500. In order to qualify, your loan must have been made solely to cover qualified educational expenses.

Note that this is an "above-the-line" deduction on your Form 1040. This means you do not need to itemize your deductions to claim it. The deduction is limited to you, your spouse or your dependent.

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During the borrowing period, this individual must have been enrolled at least half time in a degree or certificate program at an eligible educational institution.

The deduction is also subject to income limits and phases out if your income exceeds $65,000 if you're single or $130,000 if married and filing jointly. Singles who earn $80,000, or $160,000 if married and filing jointly, cannot claim it at all.

"If you've been through a four-year undergraduate program and you live just outside of New York City or Boston, then you're making good money just to exist because of the cost of living," said Morrissey.

"Often, professionals with a ton of student loan debt can't take advantage of the deduction by the time they feel secure in their job," he said.

"A borrower who makes $65,000 or less stands to gain the most as they are not subject to the income phaseout," said Andrew Josuweit, CEO of Student Loan Hero.

Consider a debtor who is earning $65,000 a year and is single. He would be in the 25 percent tax bracket and would be able to save $625 each year — or 25 percent of the maximum $2,500 allowed in deductible student loan interest.

If you're eligible, you'll want to take the deduction, but it won't turn college into an affordable expense for you.
Tim Steffen
director of financial planning, Robert W. Baird & Co.

You don't receive greater rewards for borrowing more and incurring greater interest expense, either.

"While borrowers who pay much more interest over a long period of time would technically benefit more from the deduction, they may be worse off overall because they still must make those interest payments," said Josuweit.

Diminishing over time

Consider that as you pay down your loan the amount of interest you pay will shrink over time. This will affect how much of the interest deduction you can claim.

In the early years of repayment, more of your monthly payment will go toward interest and a smaller portion applied to principal. The longer you've been paying down your educational debt, the less is going toward interest.

"The amount of the deduction will diminish over time as you amortize," said Tim Steffen, director of financial planning at Robert W. Baird & Co.

"If you're eligible, you'll want to take the deduction, but it won't turn college into an affordable expense for you," he said.