You recently lost a loved one and have been dealing with the grief of loss. Through the pain and sadness, you have discovered a silver lining because you were included in the person’s will as an heir with a financial gift. The extra money may come at a wonderful time to help you get ahead financially or pay off some debt. You may wonder if your large inheritance will count as income when it comes to calculating student loan repayments.

How Student Loan Payments are Calculated

Getting an education can be expensive. Many people look to federal student aid to help them get the funds they need to pay for college. Once you have completed your schooling, it will be time to pay the student debt back.

Federal government student loans give you multiple options for repaying your loans. An income-based repayment determines payments based on how much you make each pay period. All payment calculations for financial aid factor in where you live, the size of your family, and how much you earned in the previous year based on tax returns for your payment plan.

The Adjusted Gross Income

Student loan calculations are based on your adjusted gross income (AGI). If it increases, your student loan payments will also increase. The question when it comes to inheritance is if it must be reported as income. In general, inheritance isn’t seen as income, which means it’s not subject to federal taxes. Therefore, it won’t be counted as part of your AGI for student loan borrowers.

State Taxes

The state may still take taxes out on your inheritance, which will reduce the amount you get to keep. It won’t impact your AGI or student loan repayment. Most of the time, the estate will pay any taxes on an inheritance instead of burdening the beneficiary with this responsibility. In these situations, the taxes come out before the money is distributed to the heirs.

The Exception to the Rule

As with all rules, there generally is an exception. In this case, it is when the inheritance is a 401(k) or traditional IRA account. The money in these accounts hasn’t had the taxes taken out yet. You will be responsible for paying the taxes when you access the money. It will also be reported on your tax return as income, which means it will raise your AGI for that year and affect how much you receive as financial aid with higher student loan payments.

When your AGI goes back to normal, it will be reflected in your most recent tax return, which means your federal student loan payments will go back down. You do have another option to report your income for repayment with your student loan bill.

Instead of relying on tax returns that don’t accurately report your monthly income, you can provide alternative documentation for your federal student loans. Many times, this means recent pay stubs to prove the borrower’s ability to repay. Even if your inheritance is counted as income on your tax return, it’s important to know that you do have options for reporting your actual current income for student loan repayment plans.

Can Your Inheritance be Garnished for Student Loans?

Another concern you have is that your inheritance could be garnished for your student loans. In most cases, this won’t happen as long as you are making monthly payments on the financial aid you have received. If you are in default of your repayment plans, it does put your inheritance at risk.

The loan servicer of your student loans can file a lawsuit against you for not making payments as agreed. If this happens, the court could allow a lien against your bank accounts. This would include any funds you have received as an inheritance. You don’t have to worry about this happening if you just miss one monthly payment, but falling further behind can have serious consequences. You can also have your inheritance levied for back taxes.

Options to Pay Your Student Loans

To avoid this situation, you can enroll in an income-driven repayment plan, request a forbearance or deferment, or apply for loan consolidation with other debts you may have. You may be able to negotiate a settlement if you are unable to pay the full amount. It’s best to consult with an experienced attorney to help you determine the best steps to take to deal with your student loans and to create an affordable payment plan for your student loan debt.

Protecting an Inheritance from Student Loans

If you plan to give your beneficiaries a lump sum inheritance after you die, you’ll want to protect those assets from being taken for student loans and other debts. The best way to do this is with a life insurance policy or through other assets that don’t need to go through probate. Life insurance policies and retirement accounts with a designated beneficiary will go to that person rather than being used to pay off debts.

Federal student loans are automatically forgiven when a person dies. Private student loans may still need to be paid if they don’t offer automatic forgiveness. Your life insurance policy should pay for those loans to ensure the rest of the funds can go to your heirs instead of for student loan payments.

Any assets that you can keep out of probate will go directly to the heirs. They don’t need to be listed in probate, which means they won’t be used to pay off your debts, including your student loan.

Set Up a Trust

You can work with an estate planning attorney who will help you set up a trust. A trust will protect your assets from creditors, including private student loans. It will ensure that your beneficiaries receive their inheritance.

It’s best to talk to an attorney and tax preparer when dealing with complex matters like inheritance laws and student loans. They will provide legal advice and financial advice for what’s in your best interest and ensure anything you set up for your estate follows state law to protect you and your heirs.