By Dr. James M. Dahle, WCI Founder
Legislative Risk of PSLF
The Public Service Loan Forgiveness program provides tax-free forgiveness for federal direct loans once 120 monthly payments have been made toward it while employed full-time by a government employer or a non-profit (501(c)3). These payments can be made through any of the Income Based Repayment (IBR), Pay As You Earn (PAYE), Revised Pay As You Earn (RePAYE), or the standard 10 year repayment programs. Since most residencies and fellowships are non-profits, and since most residents and fellows enrolled in the various Income-Driven Repayment (IDR) programs qualify for payments that are a fraction of what they would owe in the 10 year standard repayment program, a doctor who made many relatively small payments during training stands to have a great deal of their student loan burden forgiven upon completing 120 payments. For someone who was enrolled in an IDR program during most or all of their training and is subsequently working for the military, VA, or a non-profit, going for PSLF is a no-brainer.
However, many PSLF enrollees fear the legislative risk inherent in any program that exists at the whims of Congress. Despite the fact that people are now starting to obtain PSLF, they fear the program will be changed and that they will not be grandfathered into the terms of the old program. This lack of faith in Congress leads some doctors to a drastic and potentially foolhardy course – they simply ignore the program despite the fact that it could be worth tens or even hundreds of thousands of dollars to them.
While this does allow them to refinance the loans to a slightly lower rate (potentially saving a few thousand in interest) and with proper financial management and discipline may even allow them to be debt-free sooner, it is probably a mistake when looking at their overall lifetime financial picture. The solution to a lack of faith in PSLF is not to leave the program, it is simply to hedge your bet by using a “PSLF side fund.”
Don't Give Up on PSLF
I did a podcast a week or so ago and talked about PSLF for a few minutes in it. I had a bunch of people email me to tell me they're REALLY worried PSLF isn't going to work out because the bureaucrats managing the program can't seem to keep track of what loans they have and how many valid payments they've made. They even suggest that the reason that 98% of those who have applied for PSLF so far didn't get it was NOT because they didn't understand the rules or because they couldn't fill the paperwork out right, but because the bureaucrats couldn't keep track of their payments. They may be entirely correct, although I wouldn't bet on it because I think the PSLF bureaucrats will get this paperwork thing figured out before the lawsuits start coming, or at least after the first few. But again, the solution is NOT to refinance and start paying off your loans. The solution is a “PSLF side fund” (and keeping a copy of every promissory note you've ever had, every communication you ever have with the bureaucrats, every annual certification form you've had signed, and every payment you've ever made.) But hey, if you want to pay off your loan because you're 99% sure you'll never receive PSLF, it's a free country.
PSLF Side Fund
The idea behind a PSLF Side Fund is that if, for some crazy reason, Congress changes the law AND doesn't grandfather you in (or the bureaucrats can't find record of all those payments you made), you now have a pot of money you can instantly use to pay off your student loans. If PSLF does materialize, then you can use that money for a house down payment, some really awesome vacations, a new Tesla, or add it to your retirement stash.
My goal in suggesting docs use this side fund is two-fold. First, it keeps them in a program that I believe is highly likely to give them a ton of money, eventually. Second, it keeps them from using “I'm going for PSLF” as an excuse to not live like a resident for the first 2-5 years out of residency.
Once you understand this concept, it usually seems like a no-brainer. “Of course that's what I should do,” the newly enlightened doc realizes. The next question, of course, is the one asked at the beginning of this post – what kind of account and investment should this money go into?
Where to Invest Your PSLF Side Fund
Ideally, a new residency graduate is living like a resident. This should provide enough money to max out all available retirement accounts (403b, 457b, a personal and spousal Backdoor Roth IRA, your spouse's available accounts, and maybe even an HSA), start working toward a down payment on the dream home, AND still put enough money into the PSLF side fund that it would equal the remaining student loan burden in less than 5 years. In that case, the “where” question is easily answered – in a taxable account.
However, the new graduate who has foolishly decided not to live like a resident may find that she is forced into the unsavory choice of EITHER maxing out retirement accounts OR saving up the PSLF side fund in a taxable account. In that situation, I would generally lean toward maxing out the retirement accounts for the tax benefits both short and long-term and additional asset protection. If PSLF materializes, the money is already in that tax-protected space you can never get back if you don't use.
If it does not materialize, of course, she'll be faced with the choice of whether or not to actually take money out of the retirement accounts, pay any taxes and penalties due, and pay off the loans. But at least she'll back to a net worth of “broke” whichever choice she makes. (Honestly, I'd probably leave it in the retirement accounts and continue the student loan payments, but then again I wouldn't be in that position because I lived like a resident.)
Of course, if she really thinks that PSLF is going away for her and she would actually withdraw from the accounts if it did, then she may pass on those retirement account benefits and just invest the money in taxable to decrease the withdrawal penalties.
How to Invest Your PSLF Side Fund
Once you've decided WHERE (i.e. which account) to invest your PSLF side fund, you now need to decide HOW (i.e. which investment) to put the money into. While it is generally a bad idea to invest money you may need in the next 5 years into risky investments like stocks and real estate, one must also consider the likelihood of actually needing that money in the next 5 years. If you judge that chance as highly unlikely, it's fine to invest the money as you would the rest of your retirement funds – i.e. for the long run in an aggressive mix of stocks, bonds, and real estate, although I would stay away from illiquid investments like a syndicated property.
If you think there's a pretty decent chance you're going to get hosed, then stick with safer investments such as a high-yield savings account, a bond fund, or a balanced fund. The less faith you have in PSLF, the more conservative your investment should be.
What do you think? Where and how do you think a PSLF side fund should be invested and why? Comment below!
Yes, exactly.
This is the advice that I give residents.
Hope for the best, but prepare for the worst.
Either way, you are fine.
If PSLF does pay off your loan, then you will have established excellent habits of frugality, saving, and investing. Plus your net worth will take an overnight huge jump. With no debt and a six-figure pile of investments, year 11 and beyond will build wealth rapidly.
It’s really year 5-7 out of residency, not 11.
No, I’m talking about year 11 as a doctor. That income matters too even if that of an average American household.
It is year 11 on the spreadsheets I show them. I think they should start modeling their finances when they start earning a paycheck. If they save 10% of a $60K salary that is 18K after 3 years in their Roth. They can track their negative net worth, income, and investments during residency. Then they see an income jump at the end of residency and a net worth jump at the end of year 10 when doing PSLF. Their net worth typically won’t be positive until year 10-12 on such a plan.
I call this method the “Trust, but verify” method. Have a little trust that it’ll be there, but verify that you could pay for it regardless.
The piece that ran that pointed out how 99% who tried to get PSLF were unable to do so frightened a lot of people. So, I can understand where some of this fear comes from. This is why it’s not only important to keep all of those records, but to certify with PSLF each year to make sure that your payments are counting.
TPP
Thank you for this! I am a single graduating resident with $405k in medical school loans (private med school in super HCOL city). I thankfully entered a relatively high paying specialty and just signed a contract for $450k as a hospital employee where I am eligible for PSLF. I have paid my student loans via RePAYE for the past 5 years and now will only have about 4.5 years left of paying with PSLF as an attending. I calculate my loan forgiveness to be about $200k and I plan to do exactly what you describe here in case PSLF goes away.
It’s amazing to me how many of my colleagues either have not started paying their loans during residency at all or are so convinced that PSLF is going away, they are planning to privately refinance their loans even if they are taking academic or other PSLF eligible jobs. In addition, there are so many financial advisors who don’t understand PSLF and therefore tell residents it’s a program that only works if you work in a rural or low-income area.
So thank you for again for understanding and shedding light to how young professionals in today’s environment can manage their student loan debt!!! You are a unicorn!
I can attest to the comment on bureaucrats losing track of qualified payments. All but 2 of my loans are in Repaye with the others being in IBR, and this has not changed since I started making payments on my loans. I have made 27 on-time payments while being employed by a 501c3, all while being enrolled in these income driven payment plans. I applied for the PSLF program 2 years ago and when I was accepted all my loans were transferred from Navient to the government. I have submitted 2 annual payment certification forms but yet when I log in to the government loan site it says I have only made 6 qualified payments on all my loans. I have just started pursuing this. I wrote them an email a few weeks ago and I have not yet received a response.
I’m sorry to hear of your situation. It’s unfortunately ridiculously common. Still, I think it’s worth a little work to get $200K after-tax.
Just to be devil’s advocate… I came out of residency with over $400k in debt with a yearly salary a bit more than that. Paid it all off in under 3 years. Problem is gone and I sleep well.
Well done. I agree 1X is very doable. Even 2X is a < 5 year problem.
This is exactly what my wife and I are doing. I’m an anesthesiologist and I paid off my ~$140k med school loans relatively quickly in 2-3 years. My wife’s law school loans were a different story. As government lawyer “only” making $60-70k starting out and with a loan balance of $225k, it made sense for her to do PSLF. We file Married Filing Separately and lower her AGI by maxing out all her pretax accounts (401k, 457) resulting in a minimal payment. As insurance, I fund a taxable account that would eventually equal her loan balance by the time her loans should be forgiven (just in case of the unlikely event that PSLF is repealed and there is no grandfathering in clause). That said, it is very important to be diligent in making sure you certify your qualified employment at least annually and monitor that your qualifying payments are credited on FedLoan Servicing. It behooves people to check on these things themselves.
Thank you for your input. My situation is very similar to yours. My husband paid off his student loans, but I am enrolled under the PSLF. We are married, filling separately. I maxed out my contributions to tax-advantage accts (401.backdoor roth,etc) and now considering a PSLF side fund. A follow up question for you, when you opened your taxable account, was it just a single account under your name or a joint? I’m not sure if this will have a large impact on my monthly income based repayment calculation. I am just aiming to pay the minimum for each qualified PSLF payment.
In light of this, we are thinking about opening the taxable account under my husband’s name so the gains from that account does not increase my income-based repayments for PSLF. Any recommendation is greatly appreciated. On a flip side, if I open a taxable account under my name, is there a certain amount in capital gains I have to watch out for before it affects my IBR repayment? Thank you
Additional income will increase your IDR payments. Not sure if you can have a joint account and claim it all on your husband’s return or not. Good question for your accountant.
I just started my first job as a hospitalist out of residency and I’m doing the whole “live like a resident” part with my wife. We live on a $4,000 per month budget. Since I was hired in August (I earned residency pay up until end of June) and my wife has no income this year (she is a nurse anesthesia student), I’m debating the merits of trying to max out my pre-tax contributions. My work offers a 401K, a 457B, and an HSA. I already make contributions that would max out the 401K and the HSA on a per year basis. But if I contribute such a high amount to all the accounts in the next few months of the year that I’m left with a paycheck just above my budget, I would probably still qualify for REPAYE next year and have less monthly loan payments as a work my way closer to the 10-year mark for qualifying for PSLF. I was wondering what anyone thinks about this strategy. The obvious downside is I’d have less liquid savings, which I may want, since I plan to buy a house at some point.
First, as a general rule, I’d be trying to max out Roth accounts this year, not pre-tax ones. Next year and during other peak earnings years go for the pre-tax.
Second, if you’re going for PSLF, you could be an exception to the general rule, but run the numbers and know what you’re giving up to get lower payments/more forgiveness and then make a decision.
A big part of it comes down to how likely you think it is that you go for PSLF.
Follow up to this comment. If we’re going PSLF, is the Roth or traditional IRA route recommended? 450K in loans with Crystal ball saying 300-350K new attending salary. Thanks Jim!
Traditional. New post coming out on that soon.
Glad to see someone else was wondering the same question as I.
Trust, but verify – will this post come out before we renew our resident contracts?
Are their other sources you recommend if it does not?
If we go traditional ira but our employer does not offer, how do we reduce our AGI – tell our employer and have them include as a payroll deduction or wait for a tax form from whoever we open the ira with? completely clueless
Not scheduled yet but probably in May or June I would guess.
What employer doesn’t offer a traditional 401(k) option? Never seen that, don’t even think it’s possible. If your income is low enough or your employer doesn’t offer a plan you can use a traditional IRA.
Just to add my two cents to this – I think both Boston University and Stanford don’t offer 401k/403b options to their residents. Need to double check this though, but that’s what I heard and what ‘Anonymous M’ may be referring to. Anyways, thanks for making this blog and waiting to hear back on my comment above!
If we were to do the traditional IRA option, after 3-7 years of residency, wouldn’t we be at a disadvantage when performing the backdoor Roth? Wouldn’t we be taxed quite a bit, especially given the hike in income? Am I not considering all the implications here?
It appears that most of the folks posted have decent yearly salaries close to the amount of residual student loan debt they have.
Unfortunately in my situation as a medicine subspecialist I am making $150,000 a year (been an attending for little over a year) with $480,000 in student loans (DIR of 3.2!). The 5 year pay-off plan will not cut it as after taxes/with-holdings, the disposable income available is $96,000. Iam refinancing my student loans since I also have private loans as well. My thought is 10-15 years for paying off this debt.
I save around 45%-50% of my income — I do not eat out, do not go to movies, do not go on vacations, do not drink — pretty much willingly living a very basic lifestyle. I am single, rent an apartment for relatively average price for where I live and have a car payment of $400.00 a month. Other expenses, are mainly utilities to live (don’t even have regular TV) and groceries. I do have term life insurance and recently got disability insurance.
Besides setting money aside in a 401(k), I’m finding it difficult to pull myself out of this hole anytime soon.
Any advice?
You’ve got a serious issue here with a DTI of over 3X. I discussed it more here:
https://www.whitecoatinvestor.com/what-to-do-if-you-have-monster-debt/
Let’s be honest though. It doesn’t make any sort of economic sense to borrow $480K to get a job that pays $150K. You are VERY highly dependent on PSLF. I would also be doing my darndest to figure out a path to a higher income as soon as possible, preferably at an institution that is a 501(c)3.
Hi All,
Question coming from an Internal Medicine Intern. I am planning on utilizing the PSLF program and currently all set-up making monthly payments on REPAYE. I am setting aside 33% of my resident salary. The breakdown of which is as follows: Approx. 16% to Roth IRA for retirement, 17% to an Index Fund for PSLF back-up, and a very, very small amount to my program’s unmatched 403b plan. I’m starting to wonder however, would it be wiser to abandon the Roth IRA and instead put all 33% into the Index Fund for PSLF back up?
If PSLF doesn’t work out, I will have a larger amount of money that is available without having to pay taxes dipping into a retirement account early. And in the event PSLF does work, I can always re-invest in a Roth IRA at that point.
Thoughts?
No. I’d max out the Roth IRA and if a Roth 403b is available, I’d use that before putting money into the PSLF Side Fund as an intern. If you max both of those out (seriously impressive on a resident income) I’d then start investing in taxable. The idea behind the PSLF side fund is that is a place where you put money in the first 2-5 years as an attending instead of using it to pay off your loans.
BTW- If you have any private loans, refinance them and you can start making extra payments there if you like instead of investing in taxable.
Follow-up on your use of the ‘Roth’ qualifier above: If the employer only offers a traditional 403b (i.e. no Roth 403b option & no employer contribution matching) should a resident prioritize the PSLF side fund after the Roth IRA? Or should they prioritize the traditional 403b after the Roth IRA? Thanks!
No right answer there. If you’re going for PSLF though, you generally want to do tax-deferred accounts because it lowers your AGI and thus your IDR payments and increases the amount forgiven. So some going for PSLF would prioritize the 403b over the Backdoor Roth IRA.
What are your thoughts on putting some of the side fund in a 529 in your own name? Target to have $10k by the beginning of the tenth year, which can be used for those payments in the final year of pslf (or for use before if pslf goes away).
Then you can take advantage of a state tax deduction on contributions (if applicable), and if there is growth in the account, it will be tax free (but you’d have to stop once you hit $10k, as that is the max student loan payment allowed from a 529).
In theory, a 529 could work for someone trying to pay down non-PSLF student debt, too, correct? If the goal is to have your debt paid off in a few years and you have refinanced into a very low rate (I know folks who have variable rates below 1% right now)… Then you contribute $10k to a 529, wait a month or two, then withdrawal and pay towards the loan. If your state allows a tax deduction for 529 contributions, you’d be all set, right? And if there were any gains, they’d be tax free (eg if you put in $9k, left it for a year or two, and the market happens to go up – although that is more of a gamble).
Not a bad idea. You can always change the beneficiary to your child if it pans out or pay off your loans with it if it doesn’t. Don’t forget that $10K limit.
I am at the point of starting my PSLF side fund after paying off all my private loans. I am confident enough in PSLF being around when I am eligible in 3 years to not want to keep it all in a savings account but not confident enough to put it in all stocks . Thoughts on using something like VTMFX in a taxable account in order not to miss out on growth but be insulated against the volatility of 100% stocks?
Not a huge fan of that particular fund, but it’s not a bad choice. I’d probably just put part into TSM and leave part in cash in your situation. Actually, I’d put it all in TSM because I see people getting PSLF all the time now, but if you’re not sure, then keep some in cash.
What do you recommend as far as a fund strategy? My loan burden is $420k, 10 year repayment plan is somewhere ~$4400/mo. Would you put $4400/mo in a side fund and invest it in like 70 bonds / 30 total market fund?
No right answer to this question. Your choice seems reasonable to me, but the range of reasonable is very wide. If you’re quite confident of getting PSLF, I’d invest aggressively. If not very confident at all, I’d invest pretty conservatively. Your 70/30 mix suggests you’re not very confident to me.