I recently met with a client whose Public Student Loan Forgiveness (PSLF) situation is perhaps the best I've seen in the hundreds of student loan consults I've conducted. I’ll call her Jade.
The key factors contributing to this surgeon's success are:
- Enrolling in an Income-Driven Repayment (IDR) plan during residency
- A long training period, five years in a surgery residency, and two years in a subspecialty fellowship
- Two years of no payments due to COVID forbearance
- Living in a community property state with a stay-at-home spouse
Now that the Biden administration has once again extended the student loan holiday until May 2022, let's tell the story of one doctor who is using PSLF and that loan freeze to her advantage.
Student Loans Accumulated from School
Jade had to borrow to pay for her undergraduate schooling, her graduate degree prior to medical school, and then medical school. After undergrad, she was uncertain if she wanted to go to medical school. Her graduate degree solidified her interest to become a doctor, and she entered medical school the same year she finished grad school.
In total, she borrowed $26,000 for undergrad, $136,000 for grad school, and $270,000 for medical school totaling $432,000. This doesn’t even account for the fact that most of her loans were unsubsidized and that they started accruing interest the day they were disbursed.
From undergrad to med school, Jade made little to no payments and owed $485,000 in total when she graduated from medical school. The additional $53,000 was from the interest that accrued during her time in school.
Direct Federal Consolidation During Intern Year
Instead of entering the automatic six-month grace period, she consolidated all of her student loans through a direct federal consolidation. This converted her family federal education loans (FFEL) from undergrad and grad school to direct federal ones and allowed her to move into repayment one month into residency.
This is a great move for new grads to begin repayment four to five months sooner. It means low monthly payments—most likely $0 payments for an intern year—and begins payment credit for the PSLF and its 120 qualifying monthly payments even earlier than expected.
Those who don’t consolidate their student loans during their intern year and end up pursuing PSLF will ultimately make 4-5 more payments as an attending; this situation usually equates to $2,000-$3,000 per month and an additional $8,000-$15,000 paid on your loans. These savings can be realized by the timely completion of a direct federal consolidation.
If you’re considering a direct federal consolidation but have loans from undergraduate or other degree programs, you may be eligible to consolidate them with your medical school loans and bring up the payment history for all of your loans. Speak to a student loan expert if you need help deciding whether now is the right time to consolidate your federal student loans.
Loan Repayment During Training
During her intern year, Jade enrolled into Pay As You Earn (PAYE) and made $0 payments because she had filed her taxes as an MS4 when she didn’t have any income. Each of those $0 payments would count toward PSLF.
In postgrad year 2 (PGY2), she made payments based on her income from intern year; effectively one-half of her $50,000 resident salary. Due to the poverty line deduction of two (she and her husband), she had zero dollar payments for an additional year.
From PGY3 – PGY5, she made roughly $200-$250 monthly payments. After five years in training, she had paid about $9,500 on her student loans—less than $2,000 per year.
Her PGY6 started in summer 2019 and ended in summer 2020. Due to COVID forbearance, she made no monthly payments from March until June. After six years in training, she had paid $11,000 on her student loans.
PGY7 was also during COVID forbearance, and no payments were required.
After seven years in training—five years in a general surgery residency and two years in a trauma fellowship—Jade graduated having made $11,000 in student loan payments with a loan balance of $618,000. During training, her loans had grown from $485,000 to $618,000 due to interest accrual and interest capitalization. Her loans have grown nearly $200,000 since she graduated from med school . . . boy, there's nothing like those high 6%-8% fixed federal interest rates that nearly double loan balances for many medical professionals, huh?
She missed about a year of payments from forbearances and has just less than four years left to obtain PSLF.
Loan Repayment as an Attending
After two months of working as an attending, Jade met with StudentLoanAdvice.com (SLA) to ensure she was on the optimal track to PSLF. SLA reviewed her current plan and identified a couple of key considerations:
- Community Property State Taxes
- Tax-Deferred Contributions
- PSLF Side Fund
Let's explore those a little bit more.
Community Property State Taxes
There are nine community property states in the US, and their tax laws differ from common law states. Community property tax laws can be quite beneficial for student loan repayment.
Jade, our surgeon client, is living in a community property state with a stay-at-home spouse who earns little to no income. Income is halved between spouses 50-50 when taxes are completed married filing separately in a community property state.
For example, a surgeon earning $450,000 with a stay-at-home spouse will only report 50% of their income on their tax return if they file their taxes married filing separately. This effectively drops that income from $450,000 to $225,000 on the income certification form.
Monthly payments in PAYE:
$450K * 10% = $45K / 12 = $3,750
$225K * 10% = $22.5K / 12 = $1,875
SLA identified the opportunity to cut her student loan payments in half by utilizing married filing separately. Please note: married filing separately generally increases taxes paid. Everyone needs to assess their personal situation.
If you’re interested in using this strategy to reduce your monthly payment, review our post How Does Married Filing Separately Affect Student Loans?
Tax-deferred contributions are an easy way to drop your student loan payments. Adjusted gross income or AGI is most often the number your loan servicer uses when calculating your monthly student loan payment. Contributing to a 403(b), 401(k), 457, HSA, and FSA are all ways to reduce your adjusted gross income, thereby reducing your monthly student loan payments.
By maxing out her employer's 403(b) retirement plan, SLA could drop Jade's payment a few hundred dollars per month. Note: tax-deferred contributions from 2021 will result in lower payments in 2022 and future years when she contributes.
Contributions for 2021 = $19,500
Contributions for 2022 = $20,500
Monthly savings in 2022 = $19,500 * 10% = $1,950 / 12 = $162
Maxing out her retirement plan will drop Jade’s student loan payment $162 per month over the next four years while she’s on track to PSLF, and it will save her $7,800 in student loan payments. This amount doesn’t account for the savings in taxes and the money Jade contributes to her retirement accounts.
Retirement savings in four years, contributing $20,000 per year
This result assumes a normal investment rate of return and monthly contributions to the retirement account.
PSLF Side Fund
A PSLF side fund is a backup plan in case the government changes the PSLF program for existing borrowers and makes it taxable or completely scraps it. SLA believes it’s highly unlikely the government will change the program for existing borrowers. It’s extremely difficult for the US Department of Education to retroactively change a provision on the master promissory note that borrowers signed when they took out federal student loans.
Our crystal ball is cloudy on the future of PSLF. The potential changes could be worse or better for borrowers.
Jade is expected to have ~$750,000 in loans forgiven in four years, thanks to PSLF. To prepare for this, we recommend saving up just in case the forgiven loan balance becomes taxable.
Assuming a 50% tax on $750,000, $375,000 would be the tax bill owed in the year loans are forgiven.
By investing $6,793 each month for the next four years and with a reasonable rate of return, Jade will have enough cash on hand to pay that tax bill. If PSLF stays the same and the loans are forgiven tax-free, she then has significant savings to help with her financial goals. Here’s a post to help you learn how to invest for a PSLF side fund.
Over the next four years, she will only pay about $38,881 toward her student loans.
In 2022, she won’t make payments until May 1, and assuming she doesn't have to recertify her income until 2023, she’ll have $0 payments the rest of the year.
In 2023, she can recertify her income prior to filing 2022 taxes and use her 2021 tax return to certify her income. During 2021, she worked half as a fellow and the last two months as an attending. Monthly payments in PAYE = $319. Therefore, her 2023 annual payment = $3,831.
In years 2024 and 2025, she will finally begin making payments on her attending income and the payments will significantly increase. We assume she makes the same income for both years. Monthly payments in PAYE = $1,460. Therefore, 2024 and 2025 annual payments = $17,525 and $17,525.
Jade, our high-earning surgeon, will only pay about $50,000 toward her student loans and will have the rest forgiven tax-free via PSLF. Her loan balance forgiven will be roughly $750,000.
PSLF can have a massive value-add for many healthcare professionals—in particular, those who have extended training periods and plan on working at a qualifying PSLF eligible employer.
Make sure you’re maximizing your opportunity for PSLF by booking a consultation with us at StudentLoanAdvice.com.
Do you have a similar story to Jade? Have you saved a ton of money thanks to PSLF? How much has the COVID student loan holiday helped you with your student loans? Now that the holiday has been extended until May 2022, what are your student loan plans? Comment below!