[Editor's Note: This is a guest post from Joshua Thompson, CFP, EA, a financial advisor and a frequent blog commenter who submitted a guest post last year on comparing disability insurance contracts. This post is designed to run in conjunction with yesterday's post on whether to refinance as a resident or stay in the IBR/PAYE program so you can possibly go for PSLF. We have no financial relationship at this time, but he wants readers to know that he is currently offering residents a student loan strategy/tax preparation service for $100 a year, but notes that price is subject to change, and I'm sure it will after 400 WCI readers email him this week.]
Young doctors need to have a plan for their student loans. I have clients with student loan balances ranging from $100,000 to almost $500,000. These loan balances are the largest financial concern for many of my young doctor clients. Not only are these loan balances hugely intimidating but picking the right re-payment strategy is more confusing than ever. [And it has become even more confusing this year with companies offering to refinance your loans while you're still in residency.-ed] Gone are the days of interest rates of under 3-4% (on federal loans) where your strategy was to just pay them off. Public Service Loan Forgiveness (PSLF) is an important strategy for many young doctors but understanding the program can seem complicated at first. My post here is intended to help young doctors see how to calculate their payments under IBR/PAYE. Most importantly however, this post should help young doctors decide whether to take a job at a non-profit and go for PSLF, or whether they would be better off with a for-profit practice and repaying the loans as fast as possible.
For-Profit and Non-Profit Forgiveness
There are 2 types of forgiveness under both IBR and PAYE; the least beneficial is the 25 year term for IBR and the 20 year term for PAYE. This forgiveness is for those who work in the private sector (for-profit) but make very little compared to their education debts-imagine being a resident for 20 years. The forgiveness under the “for-profit” program is taxable income when the debts are forgiven.
The other type of forgiveness under both IBR and PAYE is PSLF. This entails making 120 qualifying payments and having your loan balance forgiven after only 10 years. Qualifying payments are monthly payments based on your discretionary income while working for a “qualifying” institution. Qualifying institutions can be government agencies (military or VA) or IRS code section 501(C) employers (many teaching universities fall under this category). My focus will be to help young doctors evaluate how much PSLF they could actually qualify for.
The Two Big Questions
Before we get started there are two difficult items I address with my clients when discussing this topic. First, what are your post-training plans? Are they in a specialty or sub-specialty where there are actually jobs available at non-profits in a location they are willing to live in? Are they committed to working in an academic setting post residency? If the answers to any of these questions is no, then PSLF probably will not work for them. But if the answer is yes or maybe then now we need to see what is on the table.
A Case Study
My case study for this post will be a family physician that:
- expects to make $175,000 after training
- makes $50,000 in residency
- has a student loan debt of $250,000 when finishing medical school, $150,000 at 6.8% and 100,000 at 7.9%
- is single when entering residency and gets married in her last year of residency
- Has a child her second year as an attending physician
- Is willing to work at either a private group or a non-profit
I also assume a 2% inflation rate for the Federal Poverty level and a 5% a year increase in her salary over this time period.
|Federal Poverty Level 150% (2015)|
|Family size 1||17,655.00|
Qualifying for IBR or PAYE
The first step is to see if the young doctor qualifies for IBR or PAYE. IBR is 15% of discretionary income and PAYE is only 10%. In order to qualify for PAYE, you must not have had any federal loans before October 2007 and you must have taken out a federal student loan after October 2011.
Calculating your payments is fairly straight forward. You take your Adjusted Gross Income- the bottom number on the first page of your 1040, 1040A or line 4 on a 1040EZ. Then you subtract 150% of federal poverty level. This resulting number is your “discretionary” income (see below). If you are in IBR, you multiply your discretionary income by 15% or if you are PAYE eligible then you multiply it by 10%. Divide by 12 and this will be your monthly payment. I use annual numbers for my analysis since it is easier to see 10 years than it is to see 120 payments. When you are in residency your income is low so your payments are low. When you start working as an attending then your payments go up but there is a monthly cap on your payment. The monthly cap is what your standard payment would have been when you started IBR/PAYE. The monthly cap for this doctor would be $2,934 or $35,200 per year. So even if this doctor made $2,000,000 per year, her maximum annual payment would only be $35,200. This means that you may benefit from PSLF even if you have a relatively low balance of loans and expect to earn a high salary after say 6 or 7 years of training provided you start IBR/PAYE as soon as you start residency and wish to stay in the non-profit world.
We now have enough information to estimate this doctor’s IBR or PAYE payments:
|Calculate your annual payments|
|Payment Year||AGI||150% Poverty||IBR Annual||PAYE Annual|
|1||$ 50,000.00||$ 17,655.00||$ 4,851.75||$ 3,234.50|
|2||$ 50,750.00||$ 18,008.10||$ 4,911.29||$ 3,274.19|
|3||$ 51,511.25||$ 24,860.00||$ 3,997.69||$ 2,665.13|
|4||$ 114,000.00||$ 25,357.20||$ 13,296.42||$ 8,864.28|
|5||$ 177,625.00||$ 32,619.00||$ 21,750.90||$ 14,500.60|
|6||$ 180,289.38||$ 33,271.38||$ 22,052.70||$ 14,701.80|
|7||$ 182,993.72||$ 33,936.81||$ 22,358.54||$ 14,905.69|
|8||$ 185,738.62||$ 34,615.54||$ 22,668.46||$ 15,112.31|
|9||$ 188,524.70||$ 35,307.85||$ 22,982.53||$ 15,321.68|
|10||$ 191,352.57||$ 36,014.01||$ 23,300.78||$ 15,533.86|
|Total of payments||$ 162,171.05||$ 108,114.03|
You can already see where we are going here. This doctor took out $250,000 before residency started and we are showing an estimated total re-payment of only $162,171 under IBR and only $108,100 under PAYE, not including the beneficial effects of inflation or the time value of money. The next question is how much is expected to be forgiven? For that we need to know the weighted average interest rate for this doctor’s $250,000 loan debt and then see how her payments affect the loan balance over the next 10 years.
To calculate the weighted average interest rate you take the interest rate of all loans and prorate them according to the total balance of loans. This doctor has $250,000 in loans, $150,000 at 6.8% and $100,000 at 7.9%.
$150,000/$250000 *.068 + $100,000/$250,000*.079 = .0724 or 7.24%
|Loan balances and weighted average rate calculator|
|Calculating Weighted Ave|
|Loan Balances||$ 150,000.00||$ 100,000.00||$ –|
|$ –||$ –||$ –|
|Total loans||$ 250,000.00||$ 150,000.00||$100,000.00||$ –|
Now we are ready to estimate this doctor’s total forgiveness under both IBR and PAYE:
|Calculating PSLF under IBR||IBR|
|Loan Amount||Interest Rate||Interest per year||IBR Payment||Principal Accrued or paid||IBR/PSLF Forgiveness|
|1||$ 250,000.00||7.240%||$ 18,100.00||$ 4,851.75||$ 13,248.25|
|2||$ 263,248.25||7.240%||$ 19,059.17||$ 4,911.29||$ 14,147.89|
|3||$ 277,396.14||7.240%||$ 20,083.48||$ 3,997.69||$ 16,085.79|
|4||$ 293,481.93||7.240%||$ 21,248.09||$ 13,296.42||$ 7,951.67|
|5||$ 301,433.60||7.240%||$ 21,823.79||$ 21,750.90||$ 72.89|
|6||$ 301,506.50||7.240%||$ 21,829.07||$ 22,052.70||$ (223.63)|
|7||$ 301,282.87||7.240%||$ 21,812.88||$ 22,358.54||$ (545.66)|
|8||$ 300,737.21||7.240%||$ 21,773.37||$ 22,668.46||$ (895.09)|
|9||$ 299,842.12||7.240%||$ 21,708.57||$ 22,982.53||$ (1,273.96)|
|10||$ 298,568.17||7.240%||$ 21,616.34||$ 23,300.78||$ (1,684.45)|
|Total payments||$ 162,171.05||$ 46,883.72||$ 296,883.72|
Under IBR + PSLF this doctor has $296,883 forgiven after year 10. This is non-taxable money.
|Calculating PSLF under PAYE|
|Loan Amount||Interest Rate Ave||Interest per year||PAYE Payment||Principal accrued or paid||PAYE/PSLF Forgiveness|
|1||$ 250,000.00||7.240%||$ 18,100.00||$ 3,234.50||$ 14,865.50|
|2||$ 264,865.50||7.240%||$ 19,176.26||$ 3,274.19||$ 15,902.07|
|3||$ 280,767.57||7.240%||$ 20,327.57||$ 2,665.13||$ 17,662.45|
|4||$ 298,430.02||7.240%||$ 21,606.33||$ 8,864.28||$ 12,742.05|
|5||$ 311,172.07||7.240%||$ 22,528.86||$ 14,500.60||$ 8,028.26|
|6||$ 319,200.33||7.240%||$ 23,110.10||$ 14,701.80||$ 8,408.30|
|7||$ 327,608.64||7.240%||$ 23,718.87||$ 14,905.69||$ 8,813.17|
|8||$ 336,421.81||7.240%||$ 24,356.94||$ 15,112.31||$ 9,244.63|
|9||$ 345,666.44||7.240%||$ 25,026.25||$ 15,321.68||$ 9,704.57|
|10||$ 355,371.01||7.240%||$ 25,728.86||$ 15,533.86||$ 10,195.00|
|$ 108,114.03||$ 115,566.01||$ 365,566.01|
Under PAYE + PSLF, this doctor could have $365,566 in loans forgiven, again this is non-taxable. The loans actually grew by over $115,000 from the start of re-payment.
PSLF Works Great If You Qualify
So what does all this mean? If you are committed to PSLF this can be a great way to get out of your loan debt 10 years after graduating from medical school. I also look at this and see this forgiven amount as a way to evaluate whether or not a young doctor should follow their dreams or stay in a non-profit setting after residency/fellowship strictly for financial reasons. If you take the amount forgiven (PAYE) and divide it by .65 we get $562,400. This is the before tax equivalent of income earned by the loan forgiveness, divide this number by 7 (years as attending) and you get $80,344 of “phantom” income.
Paying Off Loans
Now, let’s assume this doctor could qualify to refinance her loans right out of medical school at 5% and not make any payments while in residency. Her loan balance grows to $290,000 by the time residency ends. Her payment per month at 5% is $3,075 or $36,910 per year or $369,100. Under PAYE this doctor repaid only $108,100. She saved $261,000 by staying in PAYE. If you divide $261,000 by .7 (assuming 30% tax bracket) you get a before tax, income equivalent of $372,800. This is the breakeven point for going into private practice for this doctor for 7 years, or $53,250 per year.
[Editor's Note: Keep in mind this calculation depends highly on the inputs. For example, if you can refinance your loans at 2% and pay them off in 2-5 years instead of 10, the difference between required salary to work at a not for profit is significantly smaller.]
Finally, IBR and PAYE can be maximized or manipulated [i.e. by changing your tax filing status, contributing to retirement plans to lower required payments.-ed] Loan repayments under a refinance cannot be manipulated other than paying off more balance faster than the term you choose.
What do you think? Have you run the numbers to help you decide whether to work at a 501(c)3 or not? Is that even an option in your field? Are you going or PSLF? Why or why not? Comment below!