Student Loan Debt and Life Insurance
One very important factor that is often over looked when it comes to discussing student debt, AKA college loan debt is:
“What happens to this debt if the “debtor” dies before it’s paid?”
Now we here at TermLife2Go specifically use the term “debtor” for a reason. We don’t want individuals to think of student debt as just a…
In fact, with the cost of college being what it is today, many of our young students who are incurring this debt will most likely be paying for it for years and years to come. Which means that these “students” will be paying on their “student debt” long after they’ve completed classes! (Some may even become Grandparents before it’s paid!)
“As of 2010, 11 percent of pre-retiree families had education debt with an average balance of $28,000. Growing debt burdens pose a threat to financial security of Americans approaching retirement, since increasing debt threatens their ability to save for retirement or to accumulate other assets, and may end up leading them to delay retirement,” New York Times
So don’t feel alone if you find yourself reading this article as a parent or grandparent looking to protect yourself from your child’s student debt burden, while you yourself are still paying off your own student debt!
Using Life Insurance to cover student loan debt
Now you may be asking…Why do I need life insurance since my student loans are forgiven upon death? Guess what, student loan forgiveness is not as clear cut as you think!
You need life insurance so your estate can pay the tax on your discharged student loans
Did you know:
- if you file bankruptcy your federal student loans will NOT be discharged?
- if you die your federal student loan is forgiven but your estate still must report the discharged portion as INCOME to the IRS, subject to federal income tax?
- if you qualify for loan forgiveness under either the Income Based Repayment (IBR) or Pay as You Earn (PAYE) programs the forgiven student loan is treated as your TAXABLE INCOME for that year?
Student Loan Forgiveness is not all it’s cracked up to be
Once upon a time you could get your student loans discharged in bankruptcy. That is no longer an option. If you are forced into a chapter 7 bankruptcy, you can rid yourself of most debt but not your federal student loans.
Relief for Underwater Student Borrowers Act: what everyone with student loans needs to know
U.S. Representative Mark Pocan (WI-02) and U.S. Representative Frederica Wilson (FL-24) have introduced H.R. 5239, known as the Relief for Underwater Student Borrowers Act. The bill allows borrowers of federal student loans that have fulfilled their repayment obligation and granted debt relief to be exempt from taxes owed on the amount of the forgiven loan. Source
“Student loan debt is weighing down our economy and holding back a generation of Americans as total student loan debt has grown to more than $1.2 trillion – more than total U.S. credit card debt,” said Rep. Mark Pocan. “This legislation closes a major gap in our tax code which penalizes some borrowers who have been granted debt relief after at least 20 years of consistent repayment towards their student loan debt.” Source
Why forgiven student loan debt that is treated as taxable income is a big deal
Under the current system, the portion of the forgiven student loan as part of either Income Based Repayment (IBR) or Pay as You Earn (PAYE) programs is treated as taxable income to the borrower. This creates a tax liability that most qualifying borrowers would be unable to afford. But note: student loans forgiven under other programs, including Public Service Loan Forgiveness and TEACH Grants, are not treated as taxable income. Source
Here is why the balance forgiven on student loans as part of either Income Based Repayment (IBR) or Pay as You Earn (PAYE) programs is treated as taxable income to the borrower a big deal. Suppose you have $100,000 of student loan debt remaining after 20 or 25 years (depending on the program you qualify for) of repayment under the income based repayment program. That entire $100,000 will be “forgiven”, i.e. you do not owe the Department of Education on your student loans. However, the Internal Revenue Service counts the forgiven loan amount as taxable income that year.
Now suppose you earned $50,000 of income that year. Well, add an additional $100,000 (the portion that was “forgiven”) to your income that year. You now owe income tax on a total income of $150,000 even though you only earned actual income of $50,000. The $150,000 of taxable income could amount to a tax bill of $75,000! So in reality, although your student loan was “forgiven”, you or your estate now owes the IRS $75,000. And the IRS does not have an income based repayment plan; they expect you to pay it all then and there.
Certain student loan cancellations qualify as exception to the inclusion as gross income. Generally, student loan forgiveness is not included as income if the forgiveness is based on the borrower working for a specific number of years in certain professions. “Public service loan forgiveness, teacher loan forgiveness, law school loan repayment assistance programs and the National Health Service Corps Loan Repayment Program are not taxable.” Source.
And death does not save your family or your estate
Public service loan forgiveness, teacher loan forgiveness, law school loan repayment assistance programs and the National Health Service Corps Loan Repayment Program are not taxable. However, loan discharges for closed schools, false certification, unpaid refunds, and death and disability are considered taxable income. Source That means that even if you die, the IRS will tax your estate for the amount forgiven.
So what is the point of student loan forgiveness?
The question then becomes, what is the point of student loan forgiveness if borrowers will simply owe the IRS instead of the Department of Education? Federal student loan debt is forgivable upon death but the discharged loan amount will be considered as income and be taxed. And taxes owed to the IRS will come out of your estate if you cannot pay because you are dead.
For example, suppose you die and you have $100,000 in federal student loans and another $25,000 in private student loans. The federal student loans will be charged as income of $100,000 and your estate will be taxed around 35% or $35,000. Your estate will also be on the hook for the entire $25,000 in private student loan debt. Now your estate can either file for bankruptcy or pay the $60,000. Upon your death, if you did not have money in the bank or life insurance to cover your debt, your family will suffer financially trying to pay your student loans.
Take action: What you can do
Reach out to your local congressman
Call or email your state representatives to encourage them to support H.R. 5239, known as the Relief for Underwater Student Borrowers Act. You can locate your representative by going here:
Have a plan in place
Life insurance to cover your student loan debt is an awesome way to provide for your family and/or estate upon your untimely death. If you have a large balance of federal student loans or private loans, it is wise to have life insurance in place that will cover your tax obligation. Under current law, your estate will pay taxes on any discharged student loan debt. And there is no loan forgiveness upon death for private loans. Therefore, student loan debt life insurance is imperative if you are carrying private or FFELP loans.
The various types of student loans
Let’s look at each type of loan one at a time
Is a federal loan, that is offered to eligible students who are enrolled in an accredited American university to help finance their education. These are typically the most common type of student loans out there and are:
- Generally easy to qualify for.
- Will typically have the lowest interest rate associated with them.
- Can have deferred interest accumulation while attending school and while loans are in deferment.
- And don’t require a CO-SIGNER to qualify.
Now for the purposes of our discussion here with regards to what happens to student debt if the debtor/student dies, in this situation, should the debtor/student die, the debt from a Stafford loan will be forgiven! But that is not the end of the story.
The sad truth is that student loans are forgiven but not forgotten. Your estate or family is still on the hook to the IRS for the discharged portion of the loan. You see, the Internal Revenue Service views the discharged student loan as income and taxes your estate accordingly.
Graduate Plus loans are also federal student loans issued by the federal government. These loans are very similar to Stafford loans and were created to help Graduate level students pay for higher education beyond a bachelor’s degree.
- Will typically have a higher interest rates than Stafford loans.
- And will require that the student/debtor to begin repayment sooner than a Stafford loan would.
Graduate Plus Loans will also be forgiven in the event that the debtor dies prior to the loan being repaid in full but once again, your estate will still owe taxes on the discharged portion.
PLUS Loans or Parent Loans for Undergraduate Students are loans that parents will take out on behalf of their children so that they can afford to attend the university of their choosing.
- Can be difficult to qualify for because the applicant will need to financially qualify for the amount being applied for.
- They will also usually have a higher interest rate than Stafford loans.
- And will require that the student/debtor begin repayment sooner than a Stafford loan would.
The “good news” is that with PLUS loans because the debt is tied directly to the parent of the undergraduate student, the loan will not only be forgiven should the “student” die, they will also be forgiven should the parent/debtor die.However, once again, the discharged portion will be included as income and your estate will be on the hook to the IRS.
Yes we are aware of the irony of using the phrase “good news” when it comes to discussing the death of a loved one, but when you compare the loan forgiveness characteristics associated with a federal loan with that of a private loan, you’ll certainly understand why we use the phrase “good news”.
When a student attends college, they will generally be issued a separate loan for each semester that they attend school. Which means that by the time that they graduate, these students will generally have around 16 to 20 individual Stafford Loans issued to them over the course of their studies.
Now rather than have to make these students have to make 16 to 20 different monthly payments, these borrowers/graduates are allowed to consolidate all of their Stafford loans (and other federal loans such as Perkins loans) together so that they can just make one monthly payment.
By creating a Consolidated loan, these students are able to not only simplify their monthly payments, they are also able to retain all of the federal benefits that were included in their original Stafford, such as:
- Low fixed interest rate.
- Forbearance and deferment benefits.
- Loan forgiveness upon death of debtor (with the same caveat above—your estate will owe the IRS income tax on the discharged amount).
Welcome to the wonderful world of Private Student Loan debt and the need for life insurance. Because there are so many different private student loan companies issuing hundreds of different types of student loans out there, it’s pretty much impossible to really give a definitive answer to what happens to unpaid student loan debt when the debtor dies.
But let’s look at what we do know:
- Private loans are difficult to qualify for because the private lender will be looking for employment record and assets to determine whether the borrower is a “good” risk.
- Undergraduate students will generally lack both employment and assets which is why a co-signer will usually be required.
- These loans, unlike federal loans, are designed to make a profit. Which means that it’s very unlikely that the private lender will simply forgive a debt due to a death especially if there are assets to be divided.
- And lastly, why is it that student loan debt is one of the few types of debt that can’t be expunged due to bankruptcy?
- The Reason: Banks have spent considerable time and energy to make sure that student loans won’t be forgiven in a bankruptcy through lobbying efforts so that students must pay back their loans even if they have filed bankruptcy.
So when it comes to private student loan debt, it’s probably safest to just assume that it won’t be forgiven with the death of the debtor. This is why it is imperative to consider life insurance to cover student loan debt.
Please note though for parents who co-signed on private loans, the current trend is for the lender to forgive the debt if the borrower dies, EVEN IF the parent co-signed. However, the lender is not required to forgive the debt so parents should be diligent and make sure the loan they are co-signing mentions that it will be discharged in the event the borrower dies.
So what should I do, I still want my kid to go to school?!?!
Well, we don’t usually like to assume things but generally college students are:
- In their early 20’s.
- Usually pretty healthy.
- Generally not on many prescription medications.
- Haven’t suffered from any serious medical conditions.
- And usually not traveling to many exotic destinations.
Which means that they should be able to qualify for a 10-30 year term life insurance policy to cover student loan debt of let’s say $100,000 to $250,000 for less than $20.00 a month. In other words, you can get cheap life insurance for student loan protection. And there is no exam student loan life insurance available as well so your child does not even have to give a blood or urine sample.
Take the next step
Now that you know how affordable life insurance to cover student loans can be, what you need to do is contact a life insurance agency that works will the best life insurance companies in the United States. By shopping around for the best premium on life insurance TermLife2Go can find the right policy tailored to your specific need.
Leave a Comment