If after the last chapter you’re not interested in attempting to dedicate your limited financial energies to a program that may or may not exist forever, ignore this chapter. This is all about minimizing your payments made during the 120 months required to achieve loan forgiveness.
When it comes to PSLF, I advocate a trust-but-verify approach. As in, do everything possible to maximize PSLF, but don’t use smaller monthly payments as an opportunity to blow extra dough on transient lifestyle goals. The best solution is to hedge your bets against a PSLF fallout by investing the difference: take any dollar you would have been spending toward your loans on the standard plan and put that toward retirement instead (or paying off other non-cancelable debts). This way, if PSLF were to suddenly disappear with no grandfathering or your employment circumstances change, you’d essentially have been investing on margin (i.e. investing with borrowed funds) and not just living your entire life with borrowed cash.
Because PSLF is a time-based program, if you can make smaller qualifying payments, then you will pay less money in total before your loan is forgiven. But also remember that outside of PSLF, making smaller payments means paying more for your loan over the long term because more interest accrues.
Minimizing payments to maximize loan forgiveness hinges on reducing the taxable income used to calculate your monthly payments. Because your IDR payment is based on 10-15% of your discretionary income, every dollar you can reduce your AGI by will reduce (“save”) 10-15 cents the following year in payments.
Also note that in REPAYE, the same maneuvering to reduce your monthly payment will also consequently increase your interest subsidy, thus lowering your effective interest rate. All of this basically amounts to utilizing “above the line” deductions.
Pretax Retirement Accounts
Because contributing to pretax (not after-tax or “Roth”) retirement accounts are the biggest and best way to reduce your taxable income, the PSLF program is essentially a subsidy on your retirement. You could consider it a partial non-employer “match.”
Generally, most people would advocate using a Roth (after-tax) option as a resident if available because residents are likely to be a lower tax bracket than they will be in retirement. Roth contributions mean you pay taxes now but not when you use the money. Since you pay taxes on it now, these contributions do not reduce your taxable income and thus do not help you minimize loan payment amounts that will be wasted with PSLF. In this context, it’s not necessarily straightforward to determine which option is best (tax bracket-related savings vs loan savings), but given current tax brackets, the traditional pretax option certainly isn’t much worse than the benefits you’d expect from a Roth (unless tax brackets change substantially in the distant future).
For example, a resident earning $50,000 and contributing up to a 5% employer match would put $2,500 toward retirement and thus save $250 the following year in PAYE/REPAYE. A nice guaranteed return of 10% but perhaps not worth agonizing over. Starting good responsible financial habits and putting money away for retirement is the right move, no matter how you choose to do it. If you do have big side income (or your spouse is a high earner and you submit your taxes married filed jointly), then shielding this income from the IDR calculation will yield bigger savings.
Regardless, even if it’s a wash for residents, it’s almost certainly a good idea for high-earning attendings to go pretax, even if their employer-sponsored 401(k)/403(b) has a Roth option. In this context, your tax bracket is more likely the same or higher (making the Roth and pre-tax choices essentially equivalent), and you’ll definitely get the 10-15% IDR partial match.
The annual contribution limit for a 401(k)/403(b) is $19,000 in 2019. Maxing that out would save you $1,800 the following year.
The annual contribution limit on a 457(b) account is also $19,000 in 2019. 457(b)s are common secondary pre-tax retirement accounts for government/state employees (and offered by an increasing number of regular nonprofits as well).
Maxing out both as an attending is a great thing to do to prepare for your future. Financial advisors call this paying yourself first, and it’s an excellent idea whether you have loans or not. In the context of PSLF, it’s even more excellent because maxing out these retirement accounts could save you $3800 in REPAYE/PAYE or $5,700 in IBR each year on top of keeping more of your money for yourself and less for Uncle Sam.
1099 income (moonlighting, solopreneurship, etc.)
If you make any money on the side as an independent contractor and not an employee (paid on a 1099 tax form instead of a W2), congratulations: you’re a small business owner.
This is common for regular old moonlighting income but also for locum tenens work, consulting, or even running a profitable website.
So, anyone earning any 1099 income is automatically running a business as the sole proprietor of a one wo(man) show. And that means you can also start a solo-401(k), an additional retirement account for your small business of one. While the $19,000 personal limit is cumulative across all 401(k) accounts, your business can also contribute 20% of its profits to your 401(k) as well up to an annual maximum of $56,000 per account in 2019.
Essentially, if you made $10,000 moonlighting but had already maxed out your $19k contribution with your main work account, you could still basically put another $2,000 from that as an employer contribution. The details of setting that all up are beyond the scope of this book, but again—regardless of your loan situation—this is something to consider if the situation applies to you.
Health Savings Accounts are special investment accounts available to certain employees with high deductible health plans. The terms are so good that they’re commonly referred to as “Stealth IRAs.”
You put money into them like a 401(k) where it can be invested and grow tax-free. If you use the money for health expenses, you get to spend it tax-free as well. If you use it for anything else, you pay taxes on it like you would a traditional pretax retirement account.
Individuals can contribute $3,500 and married people can contribute $6,900 in 2019 for folks under the age of 55.
Flex Spending Accounts
Putting money into a healthcare flexible spending account also reduces your pretax income, allowing you to pay for healthcare expenses tax-free (and also reducing loan payments). The downside to FSAs is that any money placed into one is a use-it-or-lose-it proposition, so don’t put more money into one than you anticipate spending. These are particularly helpful when you have elective procedures or are having a child–things you can at least partially plan for in advance.
For people with dependents (children or adults), you can also put up to $4,000 in a dependent care flex account to pay for childcare/eldercare. Given how expensive daycare is, anyone with young children would have no problem maxing out this benefit. Some important limitations:
- Can’t do it if you file taxes separately.
- Can’t use it to pay a stay-at-home parent
- Can’t use it to pay for actual school (like private K-12)
College savings: the 529
There are several tax-advantaged accounts to help parents saving for college. Of them, the 529 is the most popular and really the main one worth discussing.
The bottom line is that while 529s are great vehicles to save for college, contributions are not tax-deductible (for federal purposes) and thus will not save you any money for PSLF. Note that some states do provide a deduction for state taxes, however, which is nice even though it won’t affect PSLF.
However, the growth in the account and the disbursements for educational expenses are tax-free, so parents should consider utilizing these once their traditional tax-advantaged retirement accounts have been maxed out (if they plan on helping their children pay for higher education).
In 2019, the 529 contribution limit is $15,000 per parent per child per year to avoid gift tax consequences. That’s already a lot, but with multiple children, it adds up even faster. Even more egregious, parents can choose to “superfund” a 529 with five-years all at once for a maximum of $75,000 in a single year.
Final thoughts on Income-reduction techniques
After reading the above, you probably have mixed feelings:
On one hand, you can shield a lot of money from your IDR calculation.
On the other hand, in order to do that you have to put the money in places where you can’t blow it on fun things like new cars or vacations.
I hope after reading this far that you realize the latter is actually a good thing and will help keep you financially secure.
Between tax-advantaged accounts like the 403(b)/401(k), 457(b), HSA, and flexible spending accounts, a savvy borrower can reduce payments by thousands per year.
A dual-income physician couple in academia with access to all of the above could put on the order of $80,000 away toward the future pre-tax and save over $8,000 each year in loan repayment for PSLF. If you were to do this immediately upon finishing training and have these funds withdrawn from your paycheck, you would never see this money nor feel this pain. It’s very hard to grow into an income and spend money you don’t have access to.
If you max out pre-tax accounts, consider setting up a loan payoff slush fund, where you’d place extra cash in an interest-bearing online savings account, CD, or even taxable investing account (for the risk-takers). While this jumbo emergency fund could be used for a home down payment or other large expense, it would also be available to help pay down loans quickly in case circumstances change. A backup plan is always a good thing to have.
Married Filing Separately
You’ll remember that in PAYE and IBR, married couples who file taxes separately are treated as individuals for purposes of calculating student loan payments.
You’ll also remember that REPAYE closed this loophole and will account for both spouses’ joint income regardless of filing status.
When is this helpful for PSLF?
MFS is generally helpful when one spouse is high-income low-debt and the other (the one going for PSLF) is relatively low-income high-debt. The most common reason is basically residents with well-paid spouses, but any spousal pay will raise household income and thus payments.
That doc with the $200,000 loan and the $50,000 resident salary? What if their spouse had no debt and made $100,000 a year?
Filing jointly, the PAYE monthly payment would be $1,102.
Filing separately, the PAYE payment would be $268 (the same as a single resident).
You can see why people consider this a loophole. You could have a million-buck a year neurosurgeon spouse and still be paying pennies for loans as a resident and then get unlimited forgiveness years later.
Caveat: Community Property States
Living in a community property state can complicate the MFS technique. The nine community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. In these states, married couples equally share in all income and assets they acquire after the wedding. This means that when filing taxes separately, you divide your total income by two instead of each filing for the fraction you actually contribute. For practical purposes, this has two scenarios:
- If you make more than your spouse, then MFS in a community property state will lower your proportion of taxable income. This reduces your payments even more than normal (yay!).
- If your spouse makes more than you, then MFS in a community property state will raise your proportion of taxable income. This reduces your payments less than normal (boo…).
Tax software or your friendly accountant can show you what your taxes will look like run both ways.
In scenario two, you might wonder if it is possible to then use pay stubs after MFS to more accurately reflect your real income? Yes (sometimes).
From the official IDR FAQ (#34):
Q: My spouse and I file separate federal income tax returns. However, we live in a community property state and are required to combine our incomes and split the total amount evenly for federal income tax reporting purposes. If I apply for an income-driven repayment plan, can my loan servicer consider only my individual income when determining my eligibility and payment amount?
A: Your loan servicer may allow you to submit alternative documentation of your individual income that would be used instead of the AGI shown on your federal income tax return. Before you submit alternative documentation of your income, check with your loan servicer to see if this option is available.
Remember that when using paystubs, your payments are calculated based on your income only and do not take into account deductions like retirement contributions. People occasionally fall into a trap of using pay stubs only to realize that their relatively decreased income is washed away by the inability to account for the deductions they were taking.
When is filing separately not helpful?
When both spouses have similar income and debt levels or when the income differences are small overall. You’ll often pay a few hundred to a few thousand more in taxes by filing separately, so the difference in loan payments should be more than a few bucks for you to try it.
How to tell?
The impact of joint/solo income on IDR is easy to calculate using the repayment estimator. The effect of MFS on taxes is harder to anticipate but can be done by running your taxes both ways in your tax software or with an accountant. Separate filings, for example, preclude taking the (wimpy) student loan interest deduction.
Moreover, MFS taxpayers must both claim the standard deduction, or must both itemize their deductions. Any extra itemized deductions for one spouse (examples below) may be offset the lack of itemized deductions for the other, though some of this will change with the new tax reform.
Tax breaks you lose when MFS (for the 2017 tax year):
- The child and dependent care tax credit (different from a dependent care flex account discussed above)
- The adoption credit
- The Earned Income Credit (not relevant for docs)
- Tax-free exclusion of U.S. bond interest
- Tax-free exclusion of Social Security benefits
- The credit for the elderly and disabled
- The deduction for college tuition expenses
- The student loan interest deduction
- The American Opportunity Credit and Lifetime Learning Credit for higher education expenses
- The deduction of net capital losses
- Traditional IRA deductions
On the plus side, outside of PAYE/IBR savings, there are several itemized deductions that are limited by adjusted gross income (AGI). These are easier to qualify when MFS because they will make up a larger percentage of a single spouse’s income (particularly useful when the involved spouse is the one who makes less money):
- Medical expenses, deductible only to the extent they exceed 10% of AGI
- Personal casualty losses, deductible only to the extent they exceed 10% of AGI
- Miscellaneous itemized expenses, such as unreimbursed employee business expenses, fees for tax advice and preparation, and investment expenses, deductible only to the extent they exceed 2% of AGI
Note that for the latter, if you do any moonlighting or have any 1099 income, many of these income-limited deductions would be fully deductible as business expenses and thus not relevant. There are some serious perks to having even a relatively token amount of 1099 income.
If you save more in IDR payments over a 12-month span than it costs in taxes to file separately, then you should file separately from a PSLF-perspective. This may change year to year and should be re-evaluated every year come tax time.
Important Nuance: THE PAYE + REPAYE MFS COMBO for COUPLES
That’s a mouthful, but there is a potentially huge nuance for couples where both partners have significantly different debt-to-income ratios (unbalanced income vs loans), such that the MFS loophole can work for or against you depending on which plan you choose.
Imagine you and your spouse are doing MFS to lower payments for a high-debt low-earning spouse in PAYE (or IBR) as usual, but the other (high-income low-debt spouse) opts for REPAYE instead.
For the spouse in PAYE, their loans and their income are treated separately as expected.
For the spouse in REPAYE, their payment is calculated as we discussed in the prior Income-Driven Repayment chapter: a total monthly payment based on household income distributed proportionally based on the loan sizes.
That’s the key. Imagine you are the spouse with the high income and small loans. In PAYE MFS, you’d have a huge payment because of your high-income. But in REPAYE, the bulk of that payment would be calculated to go your spouse’s loans (even though they’re using the MFS loophole!). This can result in a much much lower monthly payment, since you only pay the fraction of that large household payment earmarked for your smaller loan.
If you and your spouse both have loans with different debt-to-income ratios, you need to run your numbers with the different plan combination possibilities in one of the calculators listed at the end of the book. What may be best for an individual may not always result in the lowest payments for the household! A spouse with a low debt-to-income ratio may leverage their spouse’s high DTI to lower their payments by using REPAYE to ignore the very same MFS loophole that their spouse is using in PAYE. Absurd? You bet!
FedLoan has been known to occasionally tell borrowers in IBR or PAYE who have correctly filed their taxes separately that they need to check a box saying that they are “married but cannot reasonably access [their] spouse’s information” on their annual income certification in order to utilize MFS. This is not true. That box was provided to help estranged spouses or sufferers of domestic violence. If you get this advice, ask for a supervisor.
Spousal refinance can affect PSLF
As a reminder, if you refinance your loans you cannot get them forgiven.
It’s also true that a spouse utilizing private refinancing can affect the PSLF-hopeful borrower. Two-loan couples will usually be MFJ, but if one refinances, suddenly their joint income is unchanged but their “debt” is drastically decreased because the feds only consider federal loans in their IDR calculations. That same-sized IDR payment would now be due just for the one loan, and you could even lose your partial financial hardship. If one spouse plans on refinancing, the other should be prepared to switch from REPAYE to PAYE and file separately.
Therefore, filing jointly and going for forgiveness together if you both have qualifying work may be a better option than filing separately and only one spouse refinancing or paying it down since there are tax costs to filing separately.
Amending prior tax returns
If you want to be aggressive, you can have the best of both worlds. Changing your tax filing status from separate to joint (but not vice versa) is one of the reasons the IRS allows you amend prior tax returns. Amending a prior return is a paper process, so you’ll usually need to download actual tax software (like Turbotax) in order to generate the amended returns or have an accountant do it for you.
You have three years from the original filing date to submit your amended return. Since all you’re doing is changing filing status, it actually isn’t all that complicated. In doing so, you can get the IDR benefits of MFS while recouping the initial tax losses after the fact by refiling MFJ. Sound shady? Totally. Personally, it makes me uncomfortable. But there’s literally nothing saying you can’t.
Updating Your Income
In short, you want to consider recertifying whenever your income goes down.
So, if you file together with your spouse who quits their job, is going part-time, on medical leave, etc., then recertify! The main caveat here is if you extensively utilize deductions to reduce your AGI; you will likely be required to use pay stubs to document your current income if it’s before you have a new tax return demonstrating the change–which would be fine–except that it’s possible to have your new lower salary be higher than your old higher salary minus deductions like retirement contributions. These machinations are things to do to save lots of money, not to shave off a few cents.
If you’re getting married to a non-working spouse, update to increase your family size.
Again, note that your family size should include an unborn baby that is estimated to be born during the year.