If someone offers you assistance in paying off student loans, your immediate answer might be “Go for it!” but it’s important to understand the implications.
While a parent, grandparent, employer, or even a mysterious benefactor could pay off your student loans, they may be responsible for a gift tax if they contribute more than the annual limit. The gift could also come with emotional strings attached.
Read on to learn about the gift tax — and how to repay your student loans if the responsibility is all yours.
Student Loans, Explained
As federal student loan repayment was poised to begin again on August 31, 2022 after a pandemic-related hiatus of two-plus years, and as widespread student loan forgiveness had not come to fruition, those bills were top of mind for many. Borrowers who held private loans did not have any uniform break in payments.
If you applied for private student loans or federal PLUS loans, you either applied by yourself or with a cosigner or endorser, respectively. If you have a cosigner or endorser, that person is legally responsible for repaying the loans if you are unable to do so. But if your student loans are solely in your name, you are responsible for repayment according to the outlined terms.
When you applied for student aid, getting out of student debt may have been the last thing on your mind. But when you’re starting repayment or in the midst of it, it can be challenging to pay down your loans as well as budget for your life.
More employers are offering student loan repayment as a perk. Through CARES Act legislation, employers can contribute up to $5,250 per employee toward student loans through 2025. That sum is not considered part of an employee’s taxable income.
Family members may decide to help, or your spouse may pitch in.
If it’s all on you, there are ways to make student loan payments more manageable.
Can Parents Pay Off Their Child’s Student Loans?
Yes.
If a parent is a cosigner, paying the student loans in full will not trigger a gift tax. In the mind of the IRS, the parent is not providing a gift but is merely paying off a debt.
But if a parent is not a cosigner, a gift tax could be triggered, depending on how much they pay.
The annual exclusion for gifts is $16,000 in 2022. That means an individual can give you up to $16,000 without triggering the gift tax, which the givers, not receivers, generally pay. If your parents file taxes jointly, they would be able to give a combined $32,000 a year, which could include paying down loans. Borrowers who have the good fortune to snag $16,000 from Mom, Dad, Granddad, and Grandma could get a total of $64,000 without any family member having to pay a gift tax.
To avoid triggering a gift tax, one option would be to help pay during multiple tax years. But it’s also a good idea for parents to consider their retirement plans and test what-ifs before offering to pay their children’s student loans. Working with a financial planner may help parents find a path that works for them and their children.
It’s also not an all-or-nothing decision. Some parents choose to pay a portion of student loans or offer cash toward repayment in lieu of other gifts.
Recommended: Should Parents Cosign on Student Loans?
What Happens When Someone Pays Off Student Loans For You?
A person can pay off student loans for you in a couple of ways:
• Pay the lender directly
• Pay you, with the expectation you will pay the lender
Once someone has paid off your student loans, it’s as if you had paid them off yourself. You would not have any tax liability.
Gift Tax, Explained
The gift tax applies to the transfer of any type of property (including money), or the use of income from property, without expecting to receive something of at least equal value in return, the IRS says, adding that if you make an interest-free or reduced-interest loan, you may be making a gift.
There are some exceptions. Gifts between spouses aren’t included in the gift tax. That means if you are married and your spouse pays off your loans, that would not trigger a gift tax event. (The IRS includes lawfully married same-sex couples.)
Tuition paid directly to qualifying educational institutions in the United States or overseas is also not subject to gift tax. But student loans are different.
If the gift someone is planning to give you is above the annual exclusion amount, they may want to work with a CPA or lawyer to find the most advantageous way to do so. Splitting up the gift across multiple calendar years can be one way to avoid triggering a gift tax.
Other Options to Pay Off Student Loans
Not everyone has a benefactor, and that’s OK. While someone taking your student loan balance down to zero can seem like a dream, there are realistic ways to ease the burden of student loans, no third party required.
The strategies include student loan refinancing, student loan consolidation and, in some cases, student loan forgiveness.
The one thing that won’t help: if you stop paying your student loans. Ignoring your student loan payments will result in an increased balance, additional fees, and lower credit score.
If you hold federal student loans and stop paying them, part of your wages could be garnished. Your tax refund could be withheld. If you default on a private student loan, the lender might file a suit to collect from you.
In other words, coming up with a repayment plan will be beneficial.
What Is Student Loan Consolidation?
If you have federal student loans, you may consider consolidation, or combining multiple loans into one federal loan. The interest rate is the average of all the loans’ rates, rounded up to the nearest one-eighth of one percentage point.
Federal student loan consolidation via a Direct Consolidation Loan can lower your monthly payment by giving you up to 30 years to repay your loans. It can also streamline payment processing.
Consolidating loans other than Direct Loans may give borrowers access to additional income-driven repayment plan options and Public Service Loan Forgiveness.
What Is Student Loan Forgiveness?
For federal student loan holders, there are several paths toward student loan forgiveness. They include:
• Income-based repayment. Four federal income-driven repayment programs promise loan forgiveness after 20 or 25 years of payments.
• Public Student Loan Forgiveness: This federal program was designed to help graduates working in public service have any remaining loan balance forgiven if they meet criteria that include working for a qualifying organization and making 10 years’ worth of payments.
• Disability discharge: Some people may have their loans forgiven because of total and permanent disability.
What about bankruptcy? It’s extremely difficult to have student loans discharged through bankruptcy.
And while there has been talk from lawmakers on both sides of the aisle regarding sweeping student loan forgiveness, so far that’s all it has been.
What Is Student Loan Refinancing?
Student loan refinancing is loan consolidation of sorts through a private lender. Instead of blending loans into one with an average rate, a borrower takes on one new, private student loan that will pay off previous federal and/or private student loans. The goal is a lower interest rate. The repayment term also may change.
Refinancing federal student loans will mean that borrowers will no longer be eligible for federal repayment programs and other benefits. But if a borrower has no plans to use those programs, a lower rate could make refinancing worthwhile. Getting quick rate quotes with a student loan refinancing calculator can help a borrower see how much money they might save by refinancing one or all of their loans.
Refinancing Student Loans With SoFi
Even if no one in your life is in a position to pay off your student loans, understanding your options for lowering your monthly payments or saving money over the life of the loan can give you multiple avenues toward taking control of your finances.
SoFi offers flexible terms and low fixed or variable rates on refinancing student loans.
FAQ
Can I pay off my child’s student loans?
Sure. You can pay off your child’s student loans. But …
Is paying off a child’s student loans considered a gift?
Yes. Paying student loans for someone else is considered a gift and would incur a gift tax for any gift above $16,000 in a calendar year (the gift exclusion cutoff for 2022).
That means both parents can contribute $32,000 per calendar year toward their child’s student loans sans gift tax.
Can I pay off my sibling’s student loans?
Yes. You can absolutely win sibling of the year and pay off your sibling’s student loans. Just know that any gift above $16,000 in one calendar year will trigger a gift tax that you will be responsible for paying.
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SoFi Student Loan Refinance
If you are looking to refinance federal student loans, please be aware that the White House has announced up to $20,000 of student loan forgiveness for Pell Grant recipients and $10,000 for qualifying borrowers whose student loans are federally held. Additionally, the federal student loan payment pause and interest holiday has been extended beyond December 31, 2022. Please carefully consider these changes before refinancing federally held loans with SoFi, since the amount or portion of your federal student debt that you refinance will no longer qualify for the federal loan payment suspension, interest waiver, or any other current or future benefits applicable to federal loans. If you qualify for federal student loan forgiveness and still wish to refinance, leave unrefinanced the amount you expect to be forgiven to receive your federal benefit.
CLICK HERE for more information.
Notice: SoFi refinance loans are private loans and do not have the same repayment options that the federal loan program offers such as Income-Driven Repayment plans, including Income-Contingent Repayment or PAYE. SoFi always recommends that you consult a qualified financial advisor to discuss what is best for your unique situation.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Photo credit: iStock/Halfpoint
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