By Dr. Jim Dahle, WCI Founder
Most medical students, residents, and attendings have heard that there are federal student loan forgiveness programs, however, they are often ignorant of the exact details of the programs. The best-known program is Public Service Loan Forgiveness (PSLF), a program that many academic physicians are using to eliminate their student loans. Under this program, if you make 10 years of on-time payments in a qualifying loan program while working full-time for a non-profit or government employer, the remainder of your debt is forgiven tax-free. This is an incentive from the taxpayer to go into public service but still allows borrowers to be student-loan free within 3-7 years of completion of training.
However, there are other forgiveness programs, collectively known as the Income-Driven Repayment (IDR) Forgiveness Programs. These are tied to the IDR programs, which are primarily designed to lower the required payments on your student loans. They are very useful for residents and fellows, who literally cannot afford to make regular payments on their massive loans during their training periods. However, their use after training is often a sign of a bad investment—i.e., you borrowed way too much money to get your job. For example, it simply wasn't a smart financial move to borrow $800K to get a job that pays $200K. However, the programs also function as a bit of a mercy program, kind of like bankruptcy. Rather than putting you into debtor's prison, we let you off easy and you can get a new financial start in your life. The IDR forgiveness programs include:
- Income Based Repayment (IBR) which requires payments of 15% of discretionary income for 25 years with a cap on the payments
- Pay As You Earn (PAYE) which requires payments of 10% of discretionary income for 20 years with a cap on the payments
- Revised Pay As You Earn (RePAYE) which requires payments of 10% of discretionary income for 20 (undergraduate) or 25 (graduate) years but has no cap on the payments. RePAYE also subsidizes half of unpaid interest each month.
Why I Hate the Income-Driven Repayment (IDR) Forgiveness Programs
While I acknowledge that going for IDR forgiveness can sometimes be the right financial move, at least mathematically, I hate the programs. I hate seeing doctors considering them and I hate seeing student loan specialists recommending them. Let me explain twelve reasons why.
# 1 The Tax Bomb
Perhaps the biggest reason I hate the IDR forgiveness programs is that the forgiveness is not tax-free. It is considered taxable income, is paid at your ordinary income tax rates, and is all due in the year you obtain forgiveness. That is dramatically less attractive than the PSLF program.
Let's run the numbers:
Let's say you borrowed $800K at 7% and got a $200K job afterward and are going for forgiveness under the PAYE program (20 years of payments of 10% of your discretionary income). Your payments might be $10K per year. But the interest on that loan is about $56K/year. So obviously your loan is going to grow by $46K/year. Luckily, that is simple interest and not compound interest, but even so, after 20 years your loan balance is your original $800K + $46K × 20 = $1,720,000. So now that is forgiven and you now owe taxes. If you're single in California, your tax bracket could be as high as 32% federal plus 9.3% state, or 41.3%. 41.3% of $1,720,000 is $710,360.
But wait! With that much taxable income, you're going to fill the brackets as you go. Some of that income is going to be taxed in the 32% bracket, some in the 35% bracket, and some in the 37% bracket. (Plus, lots of people think tax rates will be much higher in 20 years.) State tax brackets are progressive too in many states. In California, some of that income is going to be taxed at 9.3%, some at 10.3%, some at 11.3%, and some at 12.3%. So suffice to say, the tax bill will be more than $710,360. Perhaps $900K. PLUS, you paid $10K/year for 20 years, another $200K. So sure, you received forgiveness of your student loans. But you still ended up paying $1.1 Million anyway.
Sound like an awesome deal? Probably not. Even considering the time value of money, this is an approach only a desperate person would find attractive.
# 2 Higher Interest Rates
Another big issue with the IDR forgiveness programs is that you have to stay in the IDR payment programs. Now the government will loan you hundreds of thousands of dollars just for having a pulse and getting into dental or medical school. But they're not going to give you very good terms. Those loans are usually at least 6% and often 7%. Under current law, there is no way to refinance that loan, even if interest rates drop dramatically while staying in the IDR programs. So instead of being able to take advantage of 2%-5% rates like your classmates who are paying off their loans, you're stuck with 6%-8% loans, watching that balance skyrocket while praying nothing happens to the program for a third of your life.
# 3 You Are in Debt for 20-25 Years
Perhaps the worst part of the IDR programs is simply that you have student loan debt for a third of your life. Perhaps half of your adult life. If you start borrowing at 23 and, like many of those who end up going for IDR forgiveness defer your student loans during training, and then begin payments at age 33, you won't receive forgiveness until age 58. You would be in debt for a full 35 years. Basically half of your adult life. Just to pay for four years of school.
Personally, I became debt-free in 2017 (including mortgage), 11 years out of residency. I really like how it feels and don't plan to ever go back into debt. I dislike it so much I run my business without debt, buy cars with cash, and cash-flowed my home renovation. People who owe money have to do things they otherwise would not do. For instance, my med school “debt” forced me into a war zone, away from my family for months at a time. Consider the advice of depression-era religious leader J. Reuben Clark:
“It is a rule . . . in all the world that interest is to be paid on borrowed money. May I say something about interest? Interest never sleeps nor sickens nor dies; it never goes to the hospital; it works on Sundays and holidays; it never takes a vacation; it never visits nor travels . . . it has no love, no sympathy; it is as hard and soulless as a granite cliff. Once in debt, interest is your companion every minute of the day and night; you cannot shun it or slip away from it; you cannot dismiss it; it yields neither to entreaties, demands nor orders; and whenever you get in its way or cross its course or fail to meet its demands, it crushes you.”
Now I know that there are some protections with the IDR program. If something happens to your income (or heck, if you just want to stop working completely) your payments decrease along with your discretionary income. But that student loan debt still has significant effects on your cash flow, your investment decisions, your tax decisions, your retirement account decisions, your retirement date, and your career decisions.
# 4 Must Rely on Investment Returns
Proponents of the IDR forgiveness programs know about the tax bomb and have a plan for it. The idea is that you pay your required payment and then, in addition, invest an additional amount each month toward the tax bomb, presumably in an investment like a stock index fund. They point out that the sum total paid each month is less than what it would take to actually pay off the debt and that's why IDR forgiveness comes out ahead. However, they ignore an important principle.
Paying off debt provides a guaranteed investment return. Stock market returns are anything but guaranteed. In fact, if you wish to save up for your tax bomb using guaranteed investments like CDs or treasury bonds, you may not end up paying less overall. You would basically be borrowing at 6-8% in order to earn at 2%. Not exactly brilliant. That investment risk gets worse as you approach the forgiveness/tax bomb date. If that date is 5 years away are you going to make your asset allocation less aggressive? How about 2 years away? At a certain point, that expected return on the portfolio becomes lower, and most likely at the time when it matters most (i.e., when the portfolio is at its largest).
This is very different from a PSLF Side Fund, which is most likely just going to be folded into your retirement nest egg. The tax bomb money is definitely going to be spent and at a very specific time. If you're 100% invested with it and the market tanks 50% the year you qualify for forgiveness, you're going to be up a creek and owe money to the worst creditor in the world. The IRS may not break your kneecaps, but they can certainly drain your bank account and garnish your paychecks. Don't forget an additional factor either—this taxable account in which you are saving up for your tax bomb is very different from a Roth IRA. In order to write the check to the IRS the year you get forgiveness, you have to liquidate the account. Given your new, super-high tax bracket that year, you may be paying up to 23.8% (or more if Long Term Capital Gains [LTCG] tax rates climb) on the gains in the portfolio.
# 5 Lengthy Exposure to Legislative Risk
Lots of people going for PSLF are worried about legislative risk, the idea that Congress, the Department of Education and/or the IRS will change the rules. Although it seems likely to me those currently making PSLF-qualifying payments would be grandfathered into the old terms if there were significant change, they may be right to worry. Both conservative and progressive administrations have placed proposals in their budgets that would dramatically change the program. Bills have also been floated in the House from time to time.
With PSLF, assuming you made payments during training, you may really only be exposed to this risk for just 3-7 years. With IDR forgiveness, your exposure will be a minimum of 13 years, and perhaps as long as 22 or even 25 years. That's a lot of administrations/congresses. Now, to be fair, legislative risk can go both ways. Maybe there will be a student loan jubilee and all loans will just be forgiven. But it seems kind of cavalier to bank on that to me. Why would a doctor, who is a top 1-2% earner, take on those kinds of financial risks? One answer—desperation. They simply don't have a better option due to their debt to income ratio.
# 6 Mindset
One of the worst parts of being in debt is that it changes your mindset. I often hear people making the mathematical argument to borrow at lower interest in order to invest and hopefully earn a higher rate. The problem with this mathematically sound argument (at least if you ignore risk) is that it often is not behaviorally sound. Instead of investing the difference, people spend it. It is just really hard to maintain focus on a plan like that for decades. You become debt numb like so many doctors I run into with fat student loans, fat car payments, fat mortgages, and fat practice loan. All of a sudden they wake up at age 60 and realize they only have a half-million-dollar net worth after 30 years of physician paychecks.
# 7 Have Student Loans Longer Than 5 Years
A major part of the WCI Wealth Plan is to Live Like A Resident for 2-5 years after residency no matter what your student loan plan. A big part of your plan is to be rid of your student loans within 5 years of getting out of training. Over and over and over I see doctors doing this and becoming financially stable, then wealthy, and even financially independent relatively early in their career. Do I see that happening with doctors who are dragging out their student loans, even lower interest rate ones, for decades? Not really.
Even if you're going for PSLF, you're probably still going to be out of debt within 5 years of completion of training (7 at most if you don't build a PSLF Side Fund). But that's never going to happen with IDR forgiveness. At best, it'll be 13 years. More likely, 20-25. What a contrast between the docs I see crushing their student loans in 18 months and docs I meet who still have student loans in their 50s. The first are empowered and excited about their financial futures. The latter are depressed and burned out. Do “Future You” a favor, and figure out a way to get rid of your student loans within 5 years out of training. I still haven't met a doc who regretted doing so.
# 8 Centerpiece of Your Financial Life
# 9 Sticking It to the Taxpayer
At the end of the day, a student loan forgiveness program leaves the taxpayer, your fellow Americans, holding the bag. Under PSLF, at least you're providing them something in exchange—3 to 10 years of public service at presumably a lower salary. With IDR what are you giving the taxpayer? Nothing. You're just taking. In many ways, IDR is a mercy program. A welfare program. Like Medicaid and food stamps it is designed for people who have had bad things happen to them financially. Yes, you qualify for it. Yes, you learned the rules and you checked the boxes. But it still doesn't feel right to many of us and maybe that's why the legislative risk is so high. At the end of the day, you didn't do anything to earn the right of a potentially 7 figure windfall from the government.
#10 Now You Have to Pay for Advice
Managing student loans in the most efficacious manner for an IDR forgiveness is complicated. Almost no doctor is going to do it perfectly without paying a student loan specialist for assistance, probably multiple times over the course of the 2+ decades they are in the program. While that cost is only a few hundred dollars a time (and thus pales in comparison to the amount forgiven), it is still a very real cost. It doesn't take much advice to refinance your student loans and send the lender $10-15K monthly checks for a few years. It's a pretty simple plan. Still, don't let this item discourage you from getting advice if you are even considering this option. I still consider it money well spent and it is good to run the numbers and make an informed decision upfront. It is far more complicated than the vast majority of financial decisions you will make in your life.
# 11 Doesn't Forgive Private Loans
A lot of people with monster loans forget a really important aspect of the IDR forgiveness programs (and PSLF forgiveness for that matter). Only federal loans qualify (and sometimes not even all federal loans). Any private loans that you have still have to be paid back. If you have monster student loans (3-4X your salary), chances are good that a significant portion of them are private loans. You will need a totally separate plan to deal with those, and of course now have to deal with the complexities of having not one, but two plans for your student loans.
# 12 More Disability Insurance
While federal student loans are forgiven tax-free in the event of your death or permanent disability, they are not forgiven for temporary disabilities, even those lasting years. In fact, there will be a period of time up to a year before the IDR payments even drop due to the disability. You will want to carry a little extra disability insurance you otherwise would not in case this happens to you like it does 1 out of 7 doctors. There is a cost to that which should be incorporated into your plan.
A Few Words of Advice If You Are Considering IDR Forgiveness
Do I think nobody should ever use IDR forgiveness? No, I think it is probably still the right path for a relatively small (but growing) percentage of doctors. Which doctors? Well, primarily those with monster-size student loans, i.e. those owing 3-4X+ their gross income who for some bizarre reason are unwilling to take a job with a PSLF-qualifying employer for 3-10 years.
If you have a debt to income ratio of 1X, let's say an income of $300K and student loans of $300K, you could simply refinance the loans and live like a resident for two years and knock that out. ($75K in taxes, $75K to live on, and $150K/year toward the debt.) Even at a debt to income ratio of 2X, at which many student loan specialists may recommend an IDR forgiveness program, you can still get out of debt in less than 5 years with a simple Live Like a Resident plan. Only at ratios of 3-4X does that plan start becoming onerous (i.e., 10+ years of living like a resident).
You also need to be comfortable with several risks:
- Leverage risk
- Legislative risk
- Investment risk
and several complications/costs
- More complicated financial life
- Additional taxes (unless willing to file them twice for each year)
- Additional advisory fees
- Additional disability insurance
Is IDR forgiveness attractive to you? Why? Is it because you simply made some terrible financial decisions in your 20s while pursuing your dream to save the world? Or maybe you had something terrible happen to you (like not match).
But perhaps it is just because you want your cake and want to eat it too and aren't willing to make the sacrifices it takes to pay your bills. Do you want your fancy doctor house and your
Tesla BMW Audi Ferrari and your Paris vacations while dumping your student loans on the taxpayer without providing any sort of public service for it?
If it is mostly the first, I think IDR is for you. If it is mostly the latter, I think you ought to reconsider the risks of your plan and the benefits of a simple “refinance and payback” strategy. I think IDR forgiveness is a bad plan for most doctors.
What do you think? Are you going for IDR forgiveness? Who do you think it is right for and why? Comment below!
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