How one couple is potentially going to get $450k+ of student loans forgiven.
The following is a real plan recently put in place by Thinking Wealth (DeBoer Financial) and a client and is the first in a series outlining real-life planning situations, though liberty has been taken to change the names of the individuals and the numbers have been changed slightly for ease of readability. Thinking Wealth gained permission from the persons highlighted within this post to write about their situation, provided anonymity is given.
John and Jane Doe came to Thinking Wealth as a referral in the late spring of 2017, seeking help on a very narrowly focused topic: Jane’s student loan situation. Specifically, she had (and still does have) roughly $145k of student loan debt, all of which was incurred in a graduate program. John and Jane just weren’t sure what route they should go in setting up either a repayment plan and/or whether they could get those loans forgiven somehow. They had done some research but the rules and options were, understandably, a bit overwhelming for them.
As a quick overview, the most common varying options available to student loan borrowers, with differing eligibility, are:
- Standard Graduated
- Direct Loan Consolidation
o There are several repayment options just within the Direct Loan Consolidation alone!
- Private Refinance/Consolidation
- Income-Based Repayment
- Income-Contingent Repayment
*For the sake of saving your time as the reader, we won’t go through the exact rules of all of these programs. Please either do thorough research or engage with a professional if you want to see how these may affect your situation.
Needless to say, this topic can get very complex, very quickly.
John also has some in student loans but his load is smaller and he had significantly less flexibility in how/when to repay his due to a higher income and plans for future increases in that income.
But Jane’s situation is interesting. She works, though not full-time as they have a young child. They also hope and expect that Jane will not be a full-time employee on a consistent basis into the foreseeable future. She works for a hospital and as of June 30th of this year, she had made approximately $11k of income, with the expectation that her income would be roughly the same in the second half of the year as the first half. This would lead to an expected income of about $22k for the year. John makes approximately $60k a year with the hope of making more in the future.
They were fully willing to pay back the balance but wanted to know all of the options and which would be most efficient.
So here’s what we did. After doing a fair amount of analysis and research, we determined that if they were willing to file their taxes separately going forward, then she would be eligible for the PAYE program (other programs/approaches were considered but for the sake of brevity we’ll skip those details).
Because of the PAYE program eligibility coupled with their deciding to complete their taxes as Married Filing Separately going forward, she is ultimately going to end up with a payment somewhere between $0 and about $35 per month, compared to the nearly $1k per month she’s currently paying.
Now, the problem with that is that obviously a $35 payment won’t even cover the interest, much less pay down the principal on the loan. So Jane is willfully deciding to have a larger loan on a month-to-month basis as a result of this approach. However, so long as she makes these payments for 20 years (and in case you’re wondering, a $0 “payment” does count as one of the 240 monthly payments) her total balance will be forgiven.
Sweet, right?! Well, although this solution is probably saving this couple around a couple hundred thousand dollars, it is not a costless or riskless one.
The potential issues:
- Law Changes
What if the powers-that-be decide to change the rules. This could happen in any one of various ways, such as extending the number of years payments need to be made, changing the formula for monthly payments, or even nixing the program altogether! If this happens, then the Doe’s would have an extremely large debt burden. My two cents? I believe that if the government were to change the rules, they’d grandfather in current program enrollees, though that is just a guess.
- Changes in the Doe’s situation
If their, and in particular her, financial situation dramatically improves mid-way or late in the 20 year period, they may no longer be eligible for the lower payment schedule and thus could potentially still have to pay back the now larger loan balance as a result of having to switch to the standard repayment plan. This, of course, would be a good problem to have, as an improvement in their financial situation would hopefully allow for a seamless transition into standard repayment anyway.
On a related note to their financial situation, completing taxes as Married Filing Separately has the potential of having an adverse effect on the total tax bill due on a year-to-year basis. To be fair, in this situation, as their income and deductions are currently broken down, they will have an increase in federal income tax due but the amount pales in comparison to the amount of savings recognized by not having to make their roughly $1k per month student loan payments; so on net it’s still a winning solution.
Then there is the actual, true life, non-hypothetical issue: taxes upon forgiveness.
Specifically, as the program is written, this forgiveness is not a total free-lunch. The person being forgiven the loan balances has the total balance counted as Ordinary Income in the year of forgiveness. For this couple, the amount of forgiveness is projected to be over $450,000! This obviously is going to result in a fairly large tax bill 20 years from now. This future tax bill should not and cannot be ignored.
So here’s what we’re doing. We’re going to put around $200+ per month (though I’ve encouraged them to do whatever amount they are able to within their budget) in a taxable investment account, invested entirely in low-cost stock index funds (going this aggressive comes with its own set of risks, which the Doe’s are well aware of and willing to incur), with the goal of using these funds to pay either all or a large chunk of the future tax bill due as a result of their projected loan forgiveness.
Balances Over Time
What Will This Do For Them?
The net result of all of this is going to be a projected positive impact of between about $500-$700 every month for 20 years! *Though again, this is not a guarantee and there are risks involved, of which the client is aware.
So all told, we’re forging ahead with the PAYE loan repayment program coupled with extra monthly investing to pay for the future tax bill. If all goes to plan they will have somewhere around $450,000 of student loans forgiven 20 years from now and a somewhat large amount of funds available to pay the taxes on the forgiveness. The plan isn’t without risks but really, what plan isn’t?
Have questions? Reach out directly or comment below!
- The possibility does exist for the PSLF forgiveness, given that Jane works for a qualified 501c3. However, we aren’t planning on that being the case for 10 years. If it happens, great, but we aren’t setting that expectation.
- We’re going ultra-aggressive with the investment approach for two reasons.
- To attempt to outperform, on an annualized basis, the interest accrual on the student loans, in case the loans don’t get forgiven for some reason.
- If they do get forgiven in the PSLF program, the forgivable balance isn’t taxable. As such, the plan would be for this balance of investments to be considered retirement/long-term assets (the Doe’s are in their 20’s).
- In all reality, there will likely be some years in which payments will be made. As such, the real forgivable balance is highly likely to be less than the $450k+, with multiple tools projecting it to be closer to around $300k.
P.S. Financial planning really is a lot of fun; I pretty much always enjoy it. However, once in a while it's a ton of fun. This was one of those cases, as this couple is just a genuinely good set of people.
This post is not an endorsement by the client.