Deducting student loan interest
1. Avoid student loans at all costs 2. Pay off your student loans as quickly as possible
I am going to assume that you are one of the 44 million Americans who
You pay more in interest than you save
The bottom line is that opting to deduct your student loan interest instead of paying it off as quickly as possible is a bad idea because you always pay more in interest than you save. I won’t get into the minutia about itemizing your taxes, adjusted gross income, head of household or anything else because quite frankly it doesn’t matter. There is no scenario in which it is more advantageous to deduct loan interest on your tax return instead of paying it off. Let’s prove this by looking at the student loan debt profile of a typical American: an individual with $50,000 of student loan debt who makes a pre-tax (gross) income of $80,000 / annually.
IRS 2019 guidelines dictate that you can deduct up to $2,500 of your student loan interest if you’re single. When you ‘deduct’ something from your gross income, it just means your gross income goes down. This is good because it means you pay fewer taxes to the US Government and since the US Government couldn’t balance a household budget, you certainly don’t want them handling your money. You can see the impact in the table below, the gross income of this individual dropped from $80,000 to $77,500.
The 2019 federal tax bracket for individuals who make between $39,475 and $84,200 is 24%. This means that the federal government seizes 24 cents of every dollar you earn. Reducing the gross income from $80,000 to $77,500 means that no tax is being paid on $2,500 of the income you earned because it was “deducted away”. The net impact is that you avoid paying $600 of federal income tax as outlined below. Although
Let that sink in, we paid $2,500 of interest to avoid paying $600 of taxes. This is the dilemma of the educated but broke. We think we’re winning by deducting interest, making minimum student loan payments and investing the difference in the stock market. We think that these activities will somehow yield a more optimistic outcome, a path to financial independence, but that logic is wrong. It’s the same logic followed by the majority of Americans, yet 8 out of 10 of us can’t afford our next major emergency, 1 out of 4 of us have more in debt than in retirement and our average car payment is over $500 a month! This is the insanity of the new normal and normal is broke. Normal sucks. If you’re still on the fence about student loan debt, if you’re still asking yourself “Should I pay off my student loan debt early”, the answer is clear: pay off your student loan debt as quickly as possible. It is the only path to financial independence.
If you want to be broke (normal), please deduct your student loan interest on your 2019 tax return. If you’re tired of being educated but broke, make a resolution to pay off your student loan debt as quickly as possible.