IBR is a trap

[Margo]

I am soon to say "goodbye" to IBR for good. It sounds awesome in theory, but not worth it at the end. Sure, it was convenient and affordable to make minimum payments for a few years after graduating medical school. However, these payments cover only a fraction of monthly interest, and it ballooned to a nice $20,000 over these few years. I am not willing to spend another 20+ years making a monthly contribution for a nebulous promise of loan forgiveness in a distant future. By that time, my loan+interest will be several times over the original amount borrowed. It is also my understanding that I will have to pay taxes on this lovely giant sum of money. Thus, I am switching to a standard repayment. Whatever it will take: 10, 20, or more years. I need to see the light at the end of this financial tunnel. Just saying. Anyone who is pro-IBR and wants to prove me wrong, please comment. I don't claim I understand 100% how loans work.

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[Information Underload]

There is nothing that keeps you from paying more than your expected IBR payments and nor is there a penalty for paying ahead while on an IBR plan. I don't see anything magical about a 10-year or a 20-year set repayment plan. You can calculate out a 10-year repayment plan rate or a 12-year repayment plan and make those same payments under IBR but still have the flexibility of paying less if you need to.

 

[Margo]

There is nothing that keeps you from paying more than your expected IBR payments and nor is there a penalty for paying ahead while on an IBR plan. I don't see anything magical about a 10-year or a 20-year set repayment plan. You can calculate out a 10-year repayment plan rate or a 12-year repayment plan and make those same payments under IBR but still have the flexibility of paying less if you need to.

Under IBR 25 year plan, at the end of the term the principal balance is still there, and the interest is likely several times over the original amount borrowed. You may (or may not) have your loans forgiven, and if it happens, you have to pay a hefty tax on it. By comparison, it is my understanding that at the end of a 25 year standard plan the loan is paid off. That's the major difference. I've been trying to get some information from my lender on how loans work, with little success so far. For instance, when you borrow to buy a house, your monthly payment initially covers mostly the interest, but a portion is applied to principal balance. Over time, this ratio of interest/principal balance should decrease, so a monthly payment is largely applied towards a principal balance. I hope federal loans work the same way, anyone knows?

 

[Spydra]

There is nothing that keeps you from paying more than your expected IBR payments and nor is there a penalty for paying ahead while on an IBR plan. I don't see anything magical about a 10-year or a 20-year set repayment plan. You can calculate out a 10-year repayment plan rate or a 12-year repayment plan and make those same payments under IBR but still have the flexibility of paying less if you need to.

This is exactly how I saw IBR. As a recent graduate I'm still in my poorly paid lower level position so there is no way that I can afford the hefty loan payment on a standard plan and even the graduated plan was too high. However I am actively job hunting and once I land a new job and a bigger paycheck I can pay more than my minimum payment without penalty. Should something happen in the future.... lay off, reduced hours, illness, caring for my parents, etc then I can afford my low payment and not be stressed out or pushed into financial ruin.

I also don't think every person on IBR now will stay on IBR for the life of their loan. For many their salary will grow to the point to where it doesn't make financial sense to continue that option and they may choose to switch to a standard or graduated plan.

 

[darklabel]

I guess it mostly depends on your debt vs. income ratio. If you have the ability to pay off your loans and quickly without IBR, then it is always the best option it seems. Though a graduate or law student who has 100k+ in loans and a salary on the low end, IBR can be a God send to affordable monthly payments without worry of default.

 

[Information Underload]

Under IBR 25 year plan, at the end of the term the principal balance is still there, and the interest is likely several times over the original amount borrowed. You may (or may not) have your loans forgiven, and if it happens, you have to pay a hefty tax on it. By comparison, it is my understanding that at the end of a 25 year standard plan the loan is paid off.

Under a 25-year standard repayment plan, the principal is paid off because your calculated payment (let's say $1,000 per month) is higher than what is is for IBR (let's say $500 per month). You're paying off principal and forced to do such. So yes, you most likely will be making higher payments than under IBR (but not necessarily). That said, if you pay the same dolllar amount as a 25-year repayment plan under IBR (e.g., paying $1,000 per month under IBR), your loan will still be paid for in exactly 25-years with no additional money due. Again, there is nothing magical about a standard repayment plan. Nor is there anything magical about IBR other than that 1) you have the option of paying less than under a standard loan repayment 2) that your loans may be forgiven after 25-years, only while paying taxes on them and 3) that you may be eligible for PSLF (which you are not eligible for under a 25-year repayment plan).

It should be noted that under IBR if your income increases enough, you're still under IBR but are effectively paying the rate of a 10-year repayment program. That will be happening to me shortly.

Keep in mind, you can pay off your loans under the IBR plan in 2 or 3-years if you want. You just won't be in default if you don't make huge payments when your income is small using the IBR plan.

 

[Postictal Raiden]

Under a 25-year standard repayment plan, the principal is paid off because your calculated payment (let's say $1,000 per month) is higher than what is is for IBR (let's say $500 per month). You're paying off principal and forced to do such. So yes, you most likely will be making higher payments than under IBR (but not necessarily). That said, if you pay the same dolllar amount as a 25-year repayment plan under IBR (e.g., paying $1,000 per month under IBR), your loan will still be paid for in exactly 25-years with no additional money due. Again, there is nothing magical about a standard repayment plan. Nor is there anything magical about IBR other than that 1) you have the option of paying less than under a standard loan repayment 2) that your loans may be forgiven after 25-years, only while paying taxes on them and 3) that you may be eligible for PSLF (which you are not eligible for under a 25-year repayment plan).

It should be noted that under IBR if your income increases enough, you're still under IBR but are effectively paying the rate of a 10-year repayment program. That will be happening to me shortly.

Keep in mind, you can pay off your loans under the IBR plan in 2 or 3-years if you want. You just won't be in default if you don't make huge payments when your income is small using the IBR plan.

I agree with this. Plus, if you are doing IBR/PAYE your loans don't capitalize. Meaning, you don't pay interests on interests. To put it in numbers prospective, if you graduate med school with a debt of 300k @6.8% and, then, add on another 50k of unpaid interests during residency, you only pay interests on the principle amount (the 300K) not on the entire 350K. In this example, if one decides to pay off the entire debt in ten years while doing IBR, the monthly payment amount will be $3869. However, repaying the 350k under the standard 10-year term would result in a monthly payment amount of $4028, because now you are paying interests on the 50k of unpaid interests you accumulated during residency. The difference become much more pronounced when you assume a higher amount of unpaid interests during residency.

 

[SigmaFS]

Not managed properly or not understanding the financial nuances of IBR could result in financial hardship. As mentioned, one challenge is estimating any negative amortization (unpaid interest) and any remaining principal balance. I'm confident forgiveness will be available after 25 years (300 qualified monthly payments), but this forgiveness is currently considered taxable income. But IBR may not be relevant beginning December 2015 as Pay As You Earn (PAYE), another income driven repayment option, becomes available to all Federal Direct Loan borrowers.

PAYE has more favorable terms than IBR: no more that 10% of Adjusted Gross Income (AGI) paid on an annual basis, and a 20 year repayment schedule. Again, the concern is the negative amortization and any remaining principal at the point of forgiveness (240 qualified monthly payments). I've developed a spreadsheet to analyze the financial benefits and concerns of PAYE (I've done the same for IBR, but I believe most borrowers in IBR will migrate to PAYE in Dec 2015). Briefly, I assume principal loan balance of $350k @ 7.50% interest rate, with Year 1 AGI = $0 ending Year 20 = approx. $294k. At Year 8, I assume an annual AGI increase of 3%.

Key Data Points:

• Total PAYE payments for 20 years: $366k (This is a function of assumed annual AGI)
• Estimated Tax Liability: $254k - Here I assume an effective tax rate of 50%
• If you invest $600/month over 240 months generating an annualized rate of return = 7%, your investment value is approx. $313k. This is intended remit towards the estimated tax liability.
• The cost of the loan, given my assumptions (and I understand/appreciate they're assumptions) is ~ $510k with an effective interest rate of 4.03%

Now, amortize this loan with conventional 20-year repayment terms, your monthly payments are $2,819.58 resulting in a total cost of $676,699.

It is my opinion, managed properly, PAYE is a cost effective repayment option.

 

[Perrotfish]

Not managed properly or not understanding the financial nuances of IBR could result in financial hardship. As mentioned, one challenge is estimating any negative amortization (unpaid interest) and any remaining principal balance. I'm confident forgiveness will be available after 25 years (300 qualified monthly payments), but this forgiveness is currently considered taxable income. But IBR may not be relevant beginning December 2015 as Pay As You Earn (PAYE), another income driven repayment option, becomes available to all Federal Direct Loan borrowers.

PAYE has more favorable terms than IBR: no more that 10% of Adjusted Gross Income (AGI) paid on an annual basis, and a 20 year repayment schedule. Again, the concern is the negative amortization and any remaining principal at the point of forgiveness (240 qualified monthly payments). I've developed a spreadsheet to analyze the financial benefits and concerns of PAYE (I've done the same for IBR, but I believe most borrowers in IBR will migrate to PAYE in Dec 2015). Briefly, I assume principal loan balance of $350k @ 7.50% interest rate, with Year 1 AGI = $0 ending Year 20 = approx. $294k. At Year 8, I assume an annual AGI increase of 3%.

View attachment 185418

Key Data Points:

• Total PAYE payments for 20 years: $366k (This is a function of assumed annual AGI)
• Estimated Tax Liability: $254k - Here I assume an effective tax rate of 50%
• If you invest $600/month over 240 months generating an annualized rate of return = 7%, your investment value is approx. $313k. This is intended remit towards the estimated tax liability.
• The cost of the loan, given my assumptions (and I understand/appreciate they're assumptions) is ~ $510k with an effective interest rate of 4.03%

Now, amortize this loan with conventional 20-year repayment terms, your monthly payments are $2,819.58 resulting in a total cost of $676,699.

It is my opinion, managed properly, PAYE is a cost effective repayment option.

I have met very few people how have enough emotional distance from their finances that a million+ dollar debt load would not affect their emotional wellbeing over the course of 20 years, while simultaneously caring enough about their finances to not financially screw themselves in other ways.

Also, as I continuously point out, PAYE for high earners is a really, really low hanging piece of fruit for a budget cutting politician to pick.

 

[Lesley]

I have met very few people how have enough emotional distance from their finances that a million+ dollar debt load would not affect their emotional wellbeing over the course of 20 years, while simultaneously caring enough about their finances to not financially screw themselves in other ways.

Also, as I continuously point out, PAYE for high earners is a really, really low hanging piece of fruit for a budget cutting politician to pick.

....and they are already picking.

It seems very doubtful taxes on forgiven IBR/PAYE debt will be eliminated in the future.
I agree for most people this is a burden that would absolutely effect quality of life.
As per this article they are already tapping 20% of social security payments to cover student loan debt of regardless of the income or age of the borrower.
I think there are only two options, chomp at the bit and pay that debt off asap or do IBR/PAYE and do an earnest estimate of the debt that be forgiven at the end of the repayment period, principle and accrued interest, and have it saved and ready to pay Uncle Sam the year any remaining debt is forgiven.
Very good article.

http://www.nytimes.com/2014/09/13/b...on&region=bottom-well&WT.nav=bottom-well&_r=0

 

[SigmaFS]

Yes, PAYE and PSLF (two separate and distinct programs) will be modified. They are financially unsustainable programs. Historically, modifications to higher ed financial aid programs are effective on a going forward basis, not retroactive. It's my expectation that modifications to PAYE will be in place for the class graduating in 2018, possibly 2019. Prior to PAYE version 2, so to speak, current participant will be grandfather forward under the current PAYE terms.

Just for clarification, any forgiveness realized under IBR or PAYE is currently considered taxable income by the IRS. Not to be confused with Public Service Loan Forgiveness (PSLF), where after 10-years of qualified non-profit employment, loan forgiveness is a non-taxable event.

 

[dpmd]

Not managed properly or not understanding the financial nuances of IBR could result in financial hardship. As mentioned, one challenge is estimating any negative amortization (unpaid interest) and any remaining principal balance. I'm confident forgiveness will be available after 25 years (300 qualified monthly payments), but this forgiveness is currently considered taxable income. But IBR may not be relevant beginning December 2015 as Pay As You Earn (PAYE), another income driven repayment option, becomes available to all Federal Direct Loan borrowers.

PAYE has more favorable terms than IBR: no more that 10% of Adjusted Gross Income (AGI) paid on an annual basis, and a 20 year repayment schedule. Again, the concern is the negative amortization and any remaining principal at the point of forgiveness (240 qualified monthly payments). I've developed a spreadsheet to analyze the financial benefits and concerns of PAYE (I've done the same for IBR, but I believe most borrowers in IBR will migrate to PAYE in Dec 2015). Briefly, I assume principal loan balance of $350k @ 7.50% interest rate, with Year 1 AGI = $0 ending Year 20 = approx. $294k. At Year 8, I assume an annual AGI increase of 3%.

View attachment 185418

Key Data Points:

• Total PAYE payments for 20 years: $366k (This is a function of assumed annual AGI)
• Estimated Tax Liability: $254k - Here I assume an effective tax rate of 50%
• If you invest $600/month over 240 months generating an annualized rate of return = 7%, your investment value is approx. $313k. This is intended remit towards the estimated tax liability.
• The cost of the loan, given my assumptions (and I understand/appreciate they're assumptions) is ~ $510k with an effective interest rate of 4.03%

Now, amortize this loan with conventional 20-year repayment terms, your monthly payments are $2,819.58 resulting in a total cost of $676,699.

It is my opinion, managed properly, PAYE is a cost effective repayment option.

Did you account for taxes on the money you are investing to pay the eventual taxes on forgiveness? That would affect things unfavorably I would think.

 

[SigmaFS]

Yes, if you review the sample spreadsheet, the estimated tax liability is approx. $254k and the future investment value approx $310k. The difference accounts for the capital gains tax on the investment gain.

 

[Postictal Raiden]

Yes, if you review the sample spreadsheet, the estimated tax liability is approx. $254k and the future investment value approx $310k. The difference accounts for the capital gains tax on the investment gain.

I'm genuinely interested in knowing what type of investments that nets you a 7% annual gain?

 

[SigmaFS]

A common investment benchmark is the S & P 500 which is the 500 largest capitalized companies listed on the New York Stock Exchange or NASDAQ. Here are couple of links to the historical returns of the S & P 500:

http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html
http://www.bogleheads.org/wiki/S&P_500_index

There are many index funds that mirror the S&P 500. Vanguard 500 Index Fund has an average annual return of approximately 11% since its inception in 1976.

 

[Silent Cool]

I'm genuinely interested in knowing what type of investments that nets you a 7% annual gain?

As was mentioned, Vanguard 500.
Frankly, I would buy any of the high risk Vanguard funds, especially during market crashes, and you will probably do better than 7%.

 

[Postictal Raiden]

As was mentioned, Vanguard 500.
Frankly, I would buy any of the high risk Vanguard funds, especially during market crashes, and you will probably do better than 7%.

This is great.

As someone with projected debt of twice that of "average" med grads, I have no choice but to do governmental income base repayment options (IBR or PAYE. I don't have much faith in PSLF). My thought is to do the minimum calculated monthly payments and save on the side about 20k a year (this is number is based on my debt situation) to take care of the tax bomb that could be big as 45% of the forgiveness amount. At 7%, saving 20k a year over 15 years yields ~513k. This, in my opinion, should take care of the taxes on the forgiven amount and the taxes from the savings gain over the 15 year period.

The thought process described above is what keeping me sane for the time being.

 

[Silent Cool]

This is great.

As someone with projected debt of twice that of "average" med grads, I have no choice but to do governmental income base repayment options (IBR or PAYE. I don't have much faith in PSLF). My thought is to do the minimum calculated monthly payments and save on the side about 20k a year (this is number is based on my debt situation) to take care of the tax bomb that could be big as 45% of the forgiveness amount. At 7%, saving 20k a year over 15 years yields ~513k. This, in my opinion, should take care of the taxes on the forgiven amount and the taxes from the savings gain over the 15 year period.

The thought process described above is what keeping me sane for the time being.

Yeah check out some of the high-risk (you can select for that on the website) Vanguard funds. I say Vanguard specifically because they are generally the most diversified AND offer the lowest yearly cost.
I would recommend looking up their stock history on Yahoo and ask yourself how much cash you would have if you had bought any of these funds when they had dropped >25% from their most recent high.

 

[SigmaFS]

Ibn,

If you like, please feel free to provide me with your estimated student loan debt at repayment, est. interest rate, and projected annual AGI and I'll mock-up a personalized spreadsheet. Regarding annual AGI, you can provide annual estimates, percentage increase, or any combination.

 

[Postictal Raiden]

Ibn,

If you like, please feel free to provide me with your estimated student loan debt at repayment, est. interest rate, and projected annual AGI and I'll mock-up a personalized spreadsheet. Regarding annual AGI, you can provide annual estimates, percentage increase, or any combination.

I'm expecting to graduate med school in 2018 with a debt (undergrad for me and my wife and my med school) of 485-515K, but for the sake of simplicity let's call it 500k. The interest rates on these loans vary, but I have ran the numbers and it looks like that I will have the entire debt at a rate of 7%.

Below is all pure assumptions:
- start residency in 2018 and make about 50k/year with 5% annual increase throughout my training.
- length of training will most likely be 6 years (residency + fellowship)
- start my first attending job in 2024 and, assuming salaries keep up with inflation, make 315k/year ($250k in today's dollar value).
- will have a family of four
- Make annual repayment amount of 2k, leaving 33k of unpaid interests per year for the 6 year training period.

Based on the assumptions above, I was expecting to have a PAYE-sized annual repayment amount of 27k, which is not enough to cover the interests on my principle debt (35k/year). This means that my debt will keep growing by ~8k a year for the remainder of the repayment period, 14 years. Of course, my repayment amount will keep growing as my income grows to meet inflation (wishful thinking, i know).

Back-of-a-napkin calculation, I estimated that I will be making about 30k repayment per year and save, or better yet invest, another 20k a year for 14 years to take care of the taxes on the forgiven amount. The forgiven amount will be basically the entire principle debt (500) PLUS the interests accumulated during training (200k) PLUS whatever unpaid interests during the 14 years after training (~100k). All in all, that's 800k in forgiveness!

 

[SigmaFS]

I'm expecting to graduate med school in 2018 with a debt (undergrad for me and my wife and my med school) of 485-515K, but for the sake of simplicity let's call it 500k. The interest rates on these loans vary, but I have ran the numbers and it looks like that I will have the entire debt at a rate of 7%.

Below is all pure assumptions:
- start residency in 2018 and make about 50k/year with 5% annual increase throughout my training.
- length of training will most likely be 6 years (residency + fellowship)
- start my first attending job in 2024 and, assuming salaries keep up with inflation, make 315k/year ($250k in today's dollar value).
- will have a family of four
- Make annual repayment amount of 2k, leaving 33k of unpaid interests per year for the 6 year training period.

Based on the assumptions above, I was expecting to have a PAYE-sized annual repayment amount of 27k, which is not enough to cover the interests on my principle debt (35k/year). This means that my debt will keep growing by ~8k a year for the remainder of the repayment period, 14 years. Of course, my repayment amount will keep growing as my income grows to meet inflation (wishful thinking, i know).

Back-of-a-napkin calculation, I estimated that I will be making about 30k repayment per year and save, or better yet invest, another 20k a year for 14 years to take care of the taxes on the forgiven amount. The forgiven amount will be basically the entire principle debt (500) PLUS the interests accumulated during training (200k) PLUS whatever unpaid interests during the 14 years after training (~100k). All in all, that's 800k in forgiveness!

Thanks for sharing the information. An assumption made is a 3% annual increase in your income after 2024. Not sure how valid that assumption given the economic landscape for medicine. But, here it is...

I think one challenge you'll face is the $800/month investment in your residency years. It may be that you minimize the monthly invest during residency and increase during attending. So, assuming $0/month during residency, $1475/monthly investment for 14 years @ 7% annual return =$418,954. Should be sufficient to cover the estimated tax liability and the capital gains tax.

 

[Postictal Raiden]

Thanks for sharing the information. An assumption made is a 3% annual increase in your income after 2024. Not sure how valid that assumption given the economic landscape for medicine. But, here it is...

View attachment 185589

I think one challenge you'll face is the $800/month investment in your residency years. It may be that you minimize the monthly invest during residency and increase during attending. So, assuming $0/month during residency, $1475/monthly investment for 14 years @ 7% annual return =$418,954. Should be sufficient to cover the estimated tax liability and the capital gains tax.

Thank you for formulating this table.

Yeah, maintaining the 800/month investment during residency will be impossible given the fact that I have a family to support. 1475/month (or $17700/year) is much more manageable, and it's a little less than what I had originally planned to put away (20k/year).

The conclusion I drew from this table is that my annual repayment burden (actual repayment plus investment) is 15% of my anticipated future annual salary, and will slowly drop to 13% toward the end of the repayment period (mainly, due to salary increase with inflation, which causes the 1475 monthly investment to become a smaller fraction of my income with each progressing year).

All in all, I'll be looking forward to seeing 50% of my earning going toward income taxes and loan repayment for the first half of my career life .

 

[SigmaFS]

Thank you for formulating this table.

Yeah, maintaining the 800/month investment during residency will be impossible given the fact that I have a family to support. 1475/month (or $17700/year) is much more manageable, and it's a little less than what I had originally planned to put away (20k/year).

The conclusion I drew from this table is that my annual repayment burden (actual repayment plus investment) is 15% of my anticipated future annual salary, and will slowly drop to 13% toward the end of the repayment period (mainly, due to salary increase with inflation, which causes the 1475 monthly investment to become a smaller fraction of my income with each progressing year).

All in all, I'll be looking forward to seeing 50% of my earning going toward income taxes and loan repayment for the first half of my career life .

Yeah, a federally indentured servant.

 

[Information Underload]

The 7% return on investments needs to come with the grain of salt that you're probably going to want to cut back on equities and be moving towards fixed income as you approach pay-off time. If the market tanks and is in the dumps for several (multiple?) years, you could well end up in a situation where you're looking to pay off your loans after your savings were trashed by a bear market.

Just another consideration to add to the pile.

 

[SigmaFS]

The 7% return on investments needs to come with the grain of salt that you're probably going to want to cut back on equities and be moving towards fixed income as you approach pay-off time. If the market tanks and is in the dumps for several (multiple?) years, you could well end up in a situation where you're looking to pay off your loans after your savings were trashed by a bear market.

Just another consideration to add to the pile.

Yes, preservation of capital during the latter years of your investment period is critical. A possibility is a target date fund (Vanguard or Fidelity) which is heavily weighted towards equities in the initial investments years then moves to more conservative investments as you approach the end of your investment period.

 

[Lesley]

A critical factor is discipline. These funds can not be touched for up to 20 years other than consistently adding to them, then with interest/appreciation the money will be there when you need it for taxes on student loan forgiveness. 20 years is a long time. There may be many other reasons over two decades to touch this money, and if you do, the money may not be there when needed. Discipline will be key. I think this is going to be a huge challenge. This is why, I prefer, if at all possible, just paying it off asap. Neither option is easy to swallow, but as they say, sometimes it's better to take your medicine sooner than later.

 

[user3]

Also, as I continuously point out, PAYE for high earners is a really, really low hanging piece of fruit for a budget cutting politician to pick.

Back during the PSLF cap scare earlier this year, the DOE stated that any changes made would only affect future borrowers.

 

[RangerBob]

Back during the PSLF cap scare earlier this year, the DOE stated that any changes made would only affect future borrowers.

While I hope PSLF stays around for my benefit, the fact that a Democrat president seen as favorable towards students/student borrowers proposed these changes 3-4 years before anyone is eligible to benefit from PSLF suggests the odds are pretty high that someone will change the program. Back in the 80's student loans were dischargeable in bankruptcy, but the media reported a few cases of high-earning physicians and lawyers using bankruptcy to get rid of their loans and Congress overreacted and said essentially no one can discharge student loans in bankruptcy. There's going to be at least one person who borrowed money for undergrad and medical school followed by residency in neurosurgery and then a fellowship while making the minimum IBR payment (possibly $0 if they have a non-working spouse and enough kids), and then works for just 1-2 years making the max IBR/PAYE payment and will get something on the order of $500-700k forgiven. With a salary of about that much as well.

All it takes is one or two stories like that. I think the odds are very high that PSLF will be scrapped or limited and that it will apply retroactively. I think if you're a physician with a high debt burden (I am) it's in your interest to make payments eligible for PSLF, but I will pick my attending job based on what will be best for me at that time and not necessarily the one that's eligible for PSLF--until there's a contract that we sign now that clearly specifies the terms (our MPN just says we "may be eligible for forgiveness") then it's a pretty big risk to bank on PSLF.

What I plan to do if I end up at a PSLF-eligible job is continue making my IBR payments that make me eligible for PSLF. But I will also make additional payments each month (starting with my highest interest loans) so that my total monthly payments might be something close to a 15-year repayment plan--that way I still benefit if PSLF sticks around, but if it disappears I'm not screwed by making the minimum payment for so long.

If my job isn't PSLF-eligible I still plan to make IBR payments--it makes no sense at all to not be in the program unless your loans are all at the same interest rate. It allows me to make the minimum IBR payment until I make too much for my debt load (which probably won't happen for a long time) and then I can make additional payments on top of that on my GradPlus loans that are at a higher rate, all the while my other loans interest doesn't capitalize.

But I am not going to be relying on IBR forgiveness either--maybe I will make additional payments that put me on track to have my loans paid off in 30-years (I'm not eligible for PAYE--and I'll need to see what the terms of the revised PAYE are before I sign on to that) so that 5 years worth of payments are forgiven if the program is still around. But more likely I will still try and pay off my ridiculous amount of debt ASAP.

 

[cincincyreds]

i think with ibr now there is a limit on the amount forgiven, changed this year. it might be $50,000.

 

[Postictal Raiden]

i think with ibr now there is a limit on the amount forgiven, changed this year. it might be $50,000.

It was only a proposal, did it pass?

If it did then this also means that there will no longer be a tax on the forgiven balance in PAYE or IBR. Instead, the repayment term will be extended by an additional five years.

 

[RangerBob]

Unless something new came along, it was a proposal to limit that mount forgiven via PSLF, not IBR. And it did not pass--it was just part of the president's budget proposal.

 

[Silent Cool]

It was only a proposal, did it pass?

If it did then this also means that there will no longer be a tax on the forgiven balance in PAYE or IBR. Instead, the repayment term will be extended by an additional five years.

If that were the case, it would also mean that paying the minimum 10% per year would be a VERY bad idea.

Man, I really hate the federal government.

 

[Silent Cool]

Thank you for formulating this table.

Yeah, maintaining the 800/month investment during residency will be impossible given the fact that I have a family to support. 1475/month (or $17700/year) is much more manageable, and it's a little less than what I had originally planned to put away (20k/year).

The conclusion I drew from this table is that my annual repayment burden (actual repayment plus investment) is 15% of my anticipated future annual salary, and will slowly drop to 13% toward the end of the repayment period (mainly, due to salary increase with inflation, which causes the 1475 monthly investment to become a smaller fraction of my income with each progressing year).

All in all, I'll be looking forward to seeing 50% of my earning going toward income taxes and loan repayment for the first half of my career life .

It's more like 60%.

If you earn 250K, and you owe 500K @ 7.35% on a 15 year payback, you will owe 55K per year. Your taxes on 250K will be about 100K pear year, so 155k/250K = 0.62

And that's if you earn 250K. So for a good 10 years or so, your (and many people's) effective tax rate will be more like 65-70%.

What's interesting is that individuals in France, a country classically known for high taxation, earning the equivalent in Euros, actually pay less. Their top tier tax rate (excluding the uber wealthy, of course), is 45%. But their education is 'free,' as are a variety of other other benefits.

So to put it in perspective: we will be paying ~20% higher income taxes than comparably earning individuals in France, but without the social benefits that the average person there receives, and with the psychological burden/pressure of paying back such astronomical amounts of debt.

http://www.french-property.com/guid...ion/taxation/calculation-tax-liability/rates/

 

[Postictal Raiden]

It's more like 60%.

If you earn 250K, and you owe 500K @ 7.35% on a 15 year payback, you will owe 55K per year. Your taxes on 250K will be about 100K pear year, so 155k/250K = 0.62

And that's if you earn 250K. So for a good 10 years or so, your (and many people's) effective tax rate will be more like 65-70%.

What's interesting is that individuals in France, a country classically known for high taxation, earning the equivalent in Euros, actually pay less. Their top tier tax rate (excluding the uber wealthy, of course), is 45%. But their education is 'free,' as are a variety of other other benefits.

So to put it in perspective: we will be paying ~20% higher income taxes than comparably earning individuals in France, but without the social benefits that the average person there receives, and with the psychological burden/pressure of paying back such astronomical amounts of debt.

http://www.french-property.com/guid...ion/taxation/calculation-tax-liability/rates/

Yeah. For that reason, I highly doubt that the government will do away with IBR without providing another feasible alternative.

Many people are counting on these governmental repayment options not only doctors. Even though it would be a huge financial burden for many med grads to repay their loans without government "help", most doctor would still be able to do so while having enough money left to live. However can you imagine how badly screwed will law/pharm/optometry/chiro grads be if these programs vanish?

Keeping these repayment programs in place, intact, is in the government best interest. Subjecting borrowers to pay 10-15% of their gross income for two decades followed by a massive tax bomb is a great deal. For example, an average FM doc who graduated residency owing 400k will end up paying Uncle Sam a total of $650k throughout the 20 year repayment term, including a 200k tax bomb. That's a win-win situation in my opinion. The government gets back it's money with interests while the doctor is sacrificing "only" 10% of his income plus few hundreds to be deposited monthly in a savings account to prepare for the forgiveness taxation.

 

[Silent Cool]

Yeah. For that reason, I highly doubt that the government will do away with IBR without providing another feasible alternative.

Many people are counting on these governmental repayment options not only doctors. Even though it would be a huge financial burden for many med grads to repay their loans without government "help", most doctor would still be able to do so while having enough money left to live. However can you imagine how badly screwed will law/pharm/optometry/chiro grads be if these programs vanish?

Keeping these repayment programs in place, intact, is in the government best interest. Subjecting borrowers to pay 10-15% of their gross income for two decades followed by a massive tax bomb is a great deal. For example, an average FM doc who graduated residency owing 400k will end up paying Uncle Sam a total of $650k throughout the 20 year repayment term, including a 200k tax bomb. That's a win-win situation in my opinion. The government gets back it's money with interests while the doctor is sacrificing "only" 10% of his income plus few hundreds to be deposited monthly in a savings account to prepare for the forgiveness taxation.

Yeah. I don't think that the government will eliminate the loan repayment programs. The one exception however is PSLF because they get much less profit from that and too many borrowers would go that route.

The other programs will certainly stay in place.

Even so, the entire country will be at least 10% poorer.

 

[Lesley]

If that were the case, it would also mean that paying the minimum 10% per year would be a VERY bad idea.

I do think paying the minimum 10% is a bad idea. I think, in retrospect, it will be viewed that way by many. Better for most to pay it off sooner than later, ideally with a fixed payment over a set number of years and fronting more principle whenever possible. Planing to save/invest for the taxes owed on the forgiveness after 20 or more years is going to be very difficult. "The best laid plans of mice and men often go astray..." Robert Burns*

*A favorite...after all he did write "Bonnie Lesley" : )

 

[SigmaFS]

Yeah. For that reason, I highly doubt that the government will do away with IBR without providing another feasible alternative.

Many people are counting on these governmental repayment options not only doctors. Even though it would be a huge financial burden for many med grads to repay their loans without government "help", most doctor would still be able to do so while having enough money left to live. However can you imagine how badly screwed will law/pharm/optometry/chiro grads be if these programs vanish?

Keeping these repayment programs in place, intact, is in the government best interest. Subjecting borrowers to pay 10-15% of their gross income for two decades followed by a massive tax bomb is a great deal. For example, an average FM doc who graduated residency owing 400k will end up paying Uncle Sam a total of $650k throughout the 20 year repayment term, including a 200k tax bomb. That's a win-win situation in my opinion. The government gets back it's money with interests while the doctor is sacrificing "only" 10% of his income plus few hundreds to be deposited monthly in a savings account to prepare for the forgiveness taxation.

I respectfully disagree that this is in best interest of the federal government(really the general taxpayer). The financial benefit is received by the IBR/PAYE borrower. If you look at a conventional 20-year amortized loan @ 7.5% w/principal balance = $350k, it results in a $2,819.58/monthly payment. Total payments then = $676,699. Please compare to the 1st PAYE spreadsheet I submitted:

• Total PAYE payment given the assumed AGI's = $366,467
• Estimated Amount Forgiven ~$509k
• Estimated Tax Liability ~ $254
  • Total effective tax rate = 50% of amount forgiven which is proportioned @ 40% fed's and 10% state

The income realized by the federal gov w/PAYE is $366,467 plus $203,600 ($509k x 40%) = $570,067. This approximately $100k less than a conventional 20 year repayment term loan. Also, the tax payment isn't realized by the federal gov until 20 years after PAYE is initiated. In the end, IBR/PAYE, I feel, is an unsustainable program which will increase the federal debt.

 

[Postictal Raiden]

I respectfully disagree that this is in best interest of the federal government(really the general taxpayer). The financial benefit is received by the IBR/PAYE borrower. If you look at a conventional 20-year amortized loan @ 7.5% w/principal balance = $350k, it results in a $2,819.58/monthly payment. Total payments then = $676,699. Please compare to the 1st PAYE spreadsheet I submitted:

• Total PAYE payment given the assumed AGI's = $366,467
• Estimated Amount Forgiven ~$509k
• Estimated Tax Liability ~ $254
  • Total effective tax rate = 50% of amount forgiven which is proportioned @ 40% fed's and 10% state

The income realized by the federal gov w/PAYE is $366,467 plus $203,600 ($509k x 40%) = $570,067. This approximately $100k less than a conventional 20 year repayment term loan. Also, the tax payment isn't realized by the federal gov until 20 years after PAYE is initiated. In the end, IBR/PAYE, I feel, is an unsustainable program which will increase the federal debt.

I don't disagree with you that IBR/PAYE is not as profitable from taxpayer point of view as the standard 10-year repayment plan. However, it is, for most, the only feasible option that is available at this point. People, nowadays, are graduating professional schools with much larger debts, and interest rates, than they can service over a 10-year repayment term. Consider a pharmacy school grad in 2014 who accumulated a debt of 300k @6.8% by the time of graduation. Reading about the current job market of the field, this person would be lucky to find a job that pays 90K. Assuming this person is single, 1/3 of his paycheck is going to go for taxes, leaving him with ~60k a year (5k a month). Repaying his debt over a 10-year term would mean that this new pharmacist needs to make $3450 a month, leaving him with $1550 to live on. This is very unsustainable in my opinion. I can see many, if not most, future grads either defaulting on their loans or utilizing different loopholes to avoid making payments (like the teacher from the article who maintained a part-time college enrollment status to avoid repaying her loans). I think the taxpayer would much rather collecting 10% of this pharmacist's income over the next two decades and then tax the remainder balance of 485k, resulting in a total repayment amount of 393k (which includes a 170k tax bomb in 2034).

 

[SigmaFS]

I don't disagree with you that IBR/PAYE is not as profitable from taxpayer point of view as the standard 10-year repayment plan. However, it is, for most, the only feasible option that is available at this point. People, nowadays, are graduating professional schools with much larger debts, and interest rates, than they can service over a 10-year repayment term. Consider a pharmacy school grad in 2014 who accumulated a debt of 300k @6.8% by the time of graduation. Reading about the current job market of the field, this person would be lucky to find a job that pays 90K. Assuming this person is single, 1/3 of his paycheck is going to go for taxes, leaving him with ~60k a year (5k a month). Repaying his debt over a 10-year term would mean that this new pharmacist needs to make $3450 a month, leaving him with $1550 to live on. This is very unsustainable in my opinion. I can see many, if not most, future grads either defaulting on their loans or utilizing different loopholes to avoid making payments (like the teacher from the article who maintained a part-time college enrollment status to avoid repaying her loans). I think the taxpayer would much rather collecting 10% of this pharmacist's income over the next two decades and then tax the remainder balance of 485k, resulting in a total repayment amount of 393k (which includes a 170k tax bomb in 2034).

It may be that you've indirectly addressed the fundamental issue; these federal programs (IBR, PAYE, PSLF, the Federal Direct Graduate PLUS Loan Program, etc.) are encouraging students to pursue professions that the markets don't support at their current levels. It also encourages school not to control their costs. But, perhaps a discussion for another thread.

Law/Dent/Pharm and some Med professionals may only experience a financially manageable lifestyle with PAYE/IBR. I certainly appreciate that as most of my clients are dentists who would be otherwise be financially challenged w/o these repayment options.

 

[Postictal Raiden]

It may be that you've indirectly addressed the fundamental issue; these federal programs (IBR, PAYE, PSLF, the Federal Direct Graduate PLUS Loan Program, etc.) are encouraging students to pursue professions that the markets don't support at their current levels. It also encourages school not to control their costs. But, perhaps a discussion for another thread.

Law/Dent/Pharm and some Med professionals may only experience a financially manageable lifestyle with PAYE/IBR. I certainly appreciate that as most of my clients are dentists who would be otherwise be financially challenged w/o these repayment options.

I was under the impression that you were a student/resident.

 

[Lesley]

I respectfully disagree that this is in best interest of the federal government(really the general taxpayer). The financial benefit is received by the IBR/PAYE borrower. If you look at a conventional 20-year amortized loan @ 7.5% w/principal balance = $350k, it results in a $2,819.58/monthly payment. Total payments then = $676,699. Please compare to the 1st PAYE spreadsheet I submitted:

• Total PAYE payment given the assumed AGI's = $366,467
• Estimated Amount Forgiven ~$509k
• Estimated Tax Liability ~ $254
  • Total effective tax rate = 50% of amount forgiven which is proportioned @ 40% fed's and 10% state

The income realized by the federal gov w/PAYE is $366,467 plus $203,600 ($509k x 40%) = $570,067. This approximately $100k less than a conventional 20 year repayment term loan. Also, the tax payment isn't realized by the federal gov until 20 years after PAYE is initiated. In the end, IBR/PAYE, I feel, is an unsustainable program which will increase the federal debt.

Do you think your clients are saving now and do you think they will have the estimated tax liabilities saved when their loans are forgiven? $254,000 is a lot of money owed at a time when they may still have mortgages, business loans, car loans, kids in college, etc. If they don't have enough saved at that point in time, what suggestions will you have for them to come up with the cash needed to pay off their taxes, home equity loans, tapping their kids college funds? If they tap home equity loans, 401k's, IRA's there will be additional interest, possibly penalties. If their kid's have to borrow for college there is additional interest there as well. So, unless someone has the money saved to pay off the taxes owed on their student loan forgiveness at the time it is due, it becomes impossible to know the extent of true cost of IBR.

 

[SigmaFS]

I was under the impression that you were a student/resident.

Sorry if I misled you; tax advisor. I did disclose my affiliation per SDN requirements http://forums.studentdoctor.net/thr...nning-post-corporate-affliations-here.453686/.

 

[SigmaFS]

Do you think your clients are saving now and do you think they will have the estimated tax liabilities saved when their loans are forgiven? $254,000 is a lot of money owed at a time when they may still have mortgages, business loans, car loans, kids in college, etc. If they don't have enough saved at that point in time, what suggestions will you have for them to come up with the cash needed to pay off their taxes, home equity loans, tapping their kids college funds? If they tap home equity loans, 401k's, IRA's there will be additional interest, possibly penalties. If their kid's have to borrow for college there is additional interest there as well. So, unless someone has the money saved to pay off the taxes owed on their student loan forgiveness at the time it is due, it becomes impossible to know the extent of true cost of IBR.

It's a matter of educating my clients of their responsibilities in the various repayment options. And this is limited to those that I have an opportunity to address. I think most borrowers who have selected IBR/PAYE don't understand the forgiveness tax implications. I'll address more completely later as I have an 11:30 appt.

 

[SigmaFS]

Do you think your clients are saving now and do you think they will have the estimated tax liabilities saved when their loans are forgiven? $254,000 is a lot of money owed at a time when they may still have mortgages, business loans, car loans, kids in college, etc. If they don't have enough saved at that point in time, what suggestions will you have for them to come up with the cash needed to pay off their taxes, home equity loans, tapping their kids college funds? If they tap home equity loans, 401k's, IRA's there will be additional interest, possibly penalties. If their kid's have to borrow for college there is additional interest there as well. So, unless someone has the money saved to pay off the taxes owed on their student loan forgiveness at the time it is due, it becomes impossible to know the extent of true cost of IBR.

About a week ago, I met with two brother who had recently graduated from dental school with $440k each in federal student loans. They expect to earn about $90 to $100k per year for the next several years paid as independent contractors (IC). They will not receive any benefits so they're responsible to their health, malpractice and disability insurance and responsible for the employer portion of Medicare & Social Security tax (7.65%). Their tax rate will be approximately 35% netting them about $65k annually or $5,400/monthly after tax but before any insurance premiums and student loans payments. Their student loans payments @7.25% & 10 years is $5,165/month or 30 years is $3,000/month, neither of which is an attractive option. PAYE results in a payment of $687/month based on a $100k AGI. It's my expectation they will select PAYE as it's relieves some of the financial pressures. It's my responsibilities to discuss the PAYE forgiveness tax liability. And, one of the brothers asked some the same questions you raised, tapping a home/business equity loan or retirement accounts. It defeats the purpose of PAYE if you're going to extend the loan by virtue of getting another loan or depleting assets intended for another purpose. PAYE requirements more active borrower engagement, but it may be the only practical option.

I do also have some clients who are in excess of $500k student debt with income to support a 10-year conventional repayment term. Some of these clients are/have researching private loan consolidation products, such as SoFi, in order to capture a lower interest rate. In these cases, they need to be aware of the federal student loan benefits that would be lost. But from a cost perspective, it could better to move to a private loan consolidation product.

Each borrower is unique. Their individual circumstances, personal and professional goals must be evaluated to offer a repayment strategy. As mentioned, PAYE requires more borrower due diligence and financial engagement, but it could be the only practical option. It's those borrowers who enter PAYE with only the reduced monthly payments as the deciding factor that concerns me.

 

[Silent Cool]

I do think paying the minimum 10% is a bad idea. I think, in retrospect, it will be viewed that way by many. Better for most to pay it off sooner than later, ideally with a fixed payment over a set number of years and fronting more principle whenever possible. Planing to save/invest for the taxes owed on the forgiveness after 20 or more years is going to be very difficult. "The best laid plans of mice and men often go astray..." Robert Burns*

*A favorite...after all he did write "Bonnie Lesley" : )

Yeah, I agree. The problem is that then if people pay a higher percentage over 20 years, they can't save all that much. It's almost as if the system is designed to screw us either way. We're damned if we do, damned if we don't.

 

[Lesley]

Thank you for your post SigmaFS. I share your concerns. What do you think the eventual tax liability will be for the brothers with $440,000 in federal loans on the PAYE program?

 

[sazerac]

This is an awesome and factual discussion, folks. There are two caveats I would like to add.

First, when analyzing financial balloons twenty years hence, you'd really better be taking into account the time value of money, i.e. the $200K tax bomb in the year 2034 is not nearly as painful as $200K today. When I ran a similar spreadsheet that took a 3% inflation into account, the current 2014 value of all the loan payments and tax bomb ironically equalled the principal of the original loan!!!

The second caveat is that the amount of forgiveness that is taxable is limited to the amount of your current assets. The government cannot forgive you into the poorhouse. If in twenty years your assets, bank accounts, home equity, etc is only $240K, then you'd only have to declare a forgiveness income of $240K. Assuming a 1/3 tax rate, you'd only owe an additional $80K in taxes, even if $600K was forgiven.

And as an aside, while it is admirable that Ibn is going to save for the tax bomb, damn near nobody else will. Americans don't save for retirement. Americans don't save for kids' college costs. Americans sure as hell aren't gonna be saving for some weird new forgiveness tax in a couple decades when they need the latest iPhone today.

 

[SigmaFS]

Thank you for your post SigmaFS. I share your concerns. What do you think the eventual tax liability will be for the brothers with $440,000 in federal loans on the PAYE program?

We estimated Yr 1 AGI = $100k ending Yr 20 AGI = $300K.

• Total est. PAYE payments over 20 years = $310k
• Est. Amount Forgiven = $768k
• Est. Tax Liability living in CA = $384k

 

[Postictal Raiden]

We estimated Yr 1 AGI = $100k ending Yr 20 AGI = $300K.

• Total est. PAYE payments over 20 years = $310k
• Est. Amount Forgiven = $768k
• Est. Tax Liability living in CA = $384k

Assuming they invest very conservatively, how much the annual contribution needs to be to have enough to cover the tax libility if they start investing from year one?

 

[SigmaFS]

This is an awesome and factual discussion, folks. There are two caveats I would like to add.

First, when analyzing financial balloons twenty years hence, you'd really better be taking into account the time value of money, i.e. the $200K tax bomb in the year 2034 is not nearly as painful as $200K today. When I ran a similar spreadsheet that took a 3% inflation into account, the current 2014 value of all the loan payments and tax bomb ironically equalled the principal of the original loan!!!

The second caveat is that the amount of forgiveness that is taxable is limited to the amount of your current assets. The government cannot forgive you into the poorhouse. If in twenty years your assets, bank accounts, home equity, etc is only $240K, then you'd only have to declare a forgiveness income of $240K. Assuming a 1/3 tax rate, you'd only owe an additional $80K in taxes, even if $600K was forgiven.

And as an aside, while it is admirable that Ibn is going to save for the tax bomb, damn near nobody else will. Americans don't save for retirement. Americans don't save for kids' college costs. Americans sure as hell aren't gonna be saving for some weird new forgiveness tax in a couple decades when they need the latest iPhone today.

If I may respond to your caveats;

Yes, the time value of money. If you discount the future value of $200k at a 3% annual rate, your present value is approximately $110k. I really don't discuss this because the borrower will own what they own at the point of forgiveness. If they haven't saved/invested, there may not be any consolation in the time value of money discussion. But, your general premise that the loan payments plus the tax bomb = the original principal loan balance is something I would take all day long.

Caveat #2 - I believe you're referring to the insolvency provision of debt cancellation. Essentially, debt cancellation is not considered income to the extent that your liabilities exceed the fair market value of all your assets.

Finally, I agree too many of us live in the present looking for immediate gratification. Combined with too many not knowing the taxable nature of the forgiveness, this is a recipe for financial disaster