Federal Student Aid recently released its updated federal student loan statistics through September 30th, 2019. Here are some of the highlights:
- The total outstanding federal student loan balance is now $1.51 trillion. To put that in perspective, the Gross Domestic Product (GDP) of Spain is $1.50 trillion. The federal student loan balance in this country exceed the monetary value of all goods and services produced by the 13th largest country in the world, as measured by GDP. Oh, by the way, this figure doesn’t include private student loans…
- Federal student loans have increased by $853 billion in the last 10 years. It is the #2 debt in America (mortgages are #1), followed by auto loans ($1.2 trillion) and credit cards ($900 billion).
- Graduate students represent 14% of college enrollment, but hold 40% of the federal student loan debt.
- 125,000 applications were filed for Public Service Loan Forgiveness (PSLF). 99% of applications (123,439) were denied. Only 1% of applications (1,561) were granted PSLF.
This is a problem.
71% of all federal student loan debt is held by people between the ages of 25 and 49 which has a dramatic impact on their financial decisions. Think about all of the transitions you go through during these years – going to grad school, getting married, having kids, buying a home, starting a business, etc. Student loans chain people’s ability to achieve financial freedom!
On top of this, student loans are extremely complex. There are 7 types of federal student loans, 3 repayment plans that are not dependent on your income and then 5 types of repayment plans that are dependent upon your income. Oh, but wait, not all loans are eligible for all types of repayment plans.
- New Income-Based Repayment plan requires that you were a new borrower (no previous loans) as of 07/01/2014.
- Pay As You Earn (PAYE) requires that you were a new borrower (no previous loans) as of 10/01/2007 and you must have borrowed after 10/01/2011.
Are you confused yet? Okay, point made.
This blog focuses on Public Service Loan Forgiveness (PSLF) and how to avoid being the 99% of people that were denied tax-free forgiveness of their loans.
What is PSLF?
PSLF was established in 2007 and provides tax-free forgiveness of your remaining federal student loans after making 120 qualifying monthly payments, under a qualifying repayment plan, while working full-time for a qualifying employer.
That sentence alone explains why 99% of people were denied PSLF – you need the right type of loans, while on the right type of repayment plan, while working for the right type of employer.
What are the right type of loans?
Only direct public loans are eligible for PSLF. Private loans, Perkins loans and FFEL loans are all ineligible for PSLF. However, you may be able to make Perkins loans and FFEL loans eligible if you complete a direct consolidation loan which is essentially having newly issued student loans that pay off your other existing student loans.
What are the right type of repayment plans?
Only payments made under the standard 10-year repayment plan and payments under an income-based repayment plan count towards the 120 qualifying payments. All other repayment plans are not eligible. You will need to switch from the standard 10-year repayment plan to an income-based repayment plan since the standard 10 year repayment plan pays off your loans in 10 years (10 years * 12 months = 120 payments), so there would be no remaining loan balance to forgive.
What is the right type of employer?
The employer must be either a:
- 501©3 nonprofit organization
- State, local or federal government
- Americorps or Peace Corps
You also need to be employed full- time as defined by the employer. If the employer has no definition of full-time, then you need to work at least 30 hours/week in order to meet the definition. If you work part-time at 2+ different nonprofits, but it adds up to 30 hours/week, it could count.
What are the documentation requirements?
When you are on an income-based repayment plan, you need to recertify your income annually. It’s really important to stay on top of this because failure to do so could remove you from the income-based repayment plan and impede your ability to receive PSLF. This would also trigger any unpaid interest to be added to the principal loan balance which increases the amount of interest charged on your loans.
Let’s say you have $100,000 outstanding principal, a 5% interest rate and $10,000 of unpaid interest. While you are on an income-based repayment plan, you are only being charged 5% interest on the $100,000, not the extra $10,000 of unpaid interest. However, if you fail to recertify your income, the interest is “capitalized” which means the $10,000 unpaid interest is added to the $100,000 principal and you are now charged 5% interest on $100,000 + $10,000 = $110,000.
Not only do you need to meet all of the requirements above – you also need to submit employment certification forms to your loan servicer which proves your start date, end date, employment status and average hours worked when applying for PSLF. To be safe, the best practice is to do this annually or when you change employers.
Who are good candidates for PSLF?
A simple rule of thumb is if your student loan balance exceeds your income, you should seriously consider PSLF or even taxable loan forgiveness (something I spoke to Forbes about here).
In particular, doctors are great candidates for PSLF. Depending on the amount of years in residency and possibly a fellowship, they may only be a few years away from PSLF after passing the boards, assuming the hospital was a nonprofit.
This is why residency is such a crucial decision period for their student loans – if they put their student loans in forbearance during residency, they do not accrue service time towards PSLF. Since salaries are relatively lower in residency, selecting an income-based repayment plan during this time period may result in thousands of dollars of savings down the road.
Other professions include government employees, public service workers, teachers, lawyers, dentists, and more. It usually makes sense to consider PSLF when you have some type of graduate degree which likely indicates a high student debt balance.
What are some planning strategies when pursuing PSLF?
It can be scary to pursue PSLF. You shouldn’t let your student loan balance control how you spend your time. If you love working for a non-profit, great. If you dread working for a non-profit, then I wouldn’t go for PSLF. If you like, but don’t love, working for a non-profit, you may want to consider staying there depending on your student loan balance and remaining years to qualify for PSLF.
Let’s say you decide to pursue PSLF – it likely makes sense to make your payments as little as possible, which causes your loan balance to grow, but also maximizes the power of tax-free PSLF.
When you are on an income-based repayment plan (depending on the plan), there are strategies to reduce your income and thus, your subsequent student loan payments.
Take advantage of pre-tax accounts
I’m not a huge fan of putting all of your savings into pre-tax accounts, but that could make sense when you are going for PSLF. Your student loan payments are based upon your adjusted gross income which is essentially your total pre-tax income minus a bunch of deductions.
The most prevalent deductions are pre-tax employer retirement accounts (401(k), 403(b), etc.), Traditional IRAs and Health Savings Accounts. Contributions to all of these accounts lower your adjusted gross income, which in turn lowers your student loan payments.
File taxes separately if you are married…maybe
Marriage has a big impact on your student loans. From strictly a tax perspective, it almost always makes sense to file taxes jointly since it lowers your overall tax bill. However, if you file taxes jointly, your spouse’s income will now be included in your adjusted gross income, which will increase your student loan payments.
All income-based repayment plans (except REPAYE) allow you to exclude your spouse’s income from the student loan calculation if you file taxes separately. An interesting strategy is to file taxes separately, submit your income certification to your loan servicer and then amend your tax return to file jointly instead of separately. This should be discussed with your financial planner and CPA, but it is an interesting loophole to explore.
- Student loans are complex. It’s not a set it and forget it strategy – you should consider how your student loans impact all other aspects of your financial life and make sure you have the proper documentation in place.
- Be careful when going for PSLF. You need to make sure all of the criteria is met and all documentation is submitted on time. You can see why 99% of applications were denied!
- Do not, I repeat, do not automatically assume that refinancing loans is the right thing to do. Banks often try to convince borrowers to refinance by throwing low interest rates and cash bonuses at them. When you refinance loans, you lose any opportunity for PSLF. This is literally a decision that could cost you hundreds of thousands of dollars.
- Work with a Certified Student Loan Professional (CSLP). Unfortunately, most financial professionals do not have the proper training to advise on student loans. The Certified Financial Planner™ designation doesn’t cover student loans – something I find mind-boggling. This isn’t just a shameless plug because I am a CSLP® – I genuinely want people to receive the proper advice they need to help navigate through these student loan complexities. You shouldn’t have six figures of student loans as a result of pursuing education to enhance your career. Something has to change.
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