Guesting about PSLF on the Financial Residency Podcast

Listen to me and Ryan Inman of the excellent Financial Residency podcast nerd out about PSLF and why you should 1) be diligent and 2) ignore the clickbait/majority of what you read online.

Check it out.

I would normally give the disclaimer that I had a cold, but I have a four-year-old and now an infant in daycare, so I’m always either sick, recently sick, or about to be sick. Clearly my verbal tick of the day was “at the end of the day,” so mentally subtract that from your listening and it’s a great episode!

Budget and law proposals don’t matter: PSLF will work for people who already have loans

If you took out federal student loans after 2007, the master promissory note—the legal contract between you and the US government—had this buried in it:

A Public Service Loan Forgiveness (PSLF) program is also available. Under this program, we will forgive the remaining balance due on your eligible Direct Loan Program loans after you have made 120 payments on those loans (after October 1, 2007) under certain repayment plans while you are employed full-time in certain public service jobs. The required 120 payments do not have to be consecutive. Qualifying repayment plans include the REPAYE Plan, the PAYE Plan, the IBR Plan, the ICR Plan, and the Standard Repayment Plan with a 10-year repayment period.

That’s the part that makes your loan eligible for PSLF if you meet the requirements. You’ll notice there are no loan amount caps, needs testing, or other caveats. The program is in the fine print.

And this is precisely why every budget proposal from Obama (who wanted to cap the forgiven amount) and Trump (who wants to cancel the program) has specified that any change would affect new borrowers. (This is not to mention the variety of recent Democratic presidential candidate proposals to dramatically expand student loan forgiveness).

Who is a “new” borrower? Basically someone who borrows money after the law is created and doesn’t already have older loans. To illustrate how the feds have used this term in the past, look no further than the language in the MPN regarding the Pay As You Earn (PAYE) repayment plan.

The PAYE Plan is available only to new borrowers. You are a new borrower for the PAYE Plan if:

*(1)* You had no outstanding balance on a Direct Loan or a FFEL Program loan as of October 1, 2007, or you have no outstanding balance on a Direct Loan or a FFEL Program loan when you obtain a new loan on or after October 1, 2007, and

*(2)* You receive a disbursement of a Direct Subsidized Loan, Direct Unsubsidized Loan, or student Direct PLUS Loan (a Direct PLUS Loan made to a graduate or professional student) on or after October 1, 2011, or you receive a Direct Consolidation Loan based on an application received on or after October 1, 2011. However, you are not considered to be a new borrower for the PAYE Plan if the Direct Consolidation Loan you receive repays loans that would make you ineligible under part *(1)* of this definition.

Now, even the legal nuances may all be moot for at least the short term, because democrats have been more interested in expanding loan forgiveness than canceling it, and most of the gazillion of the current presidential candidates have been trying to promote free college. With Democrats controlling the house, the chances of PSLF being destroyed in the short term are pretty low. Congress couldn’t even get this done with republican majorities in the house, senate, and a sitting president.

Now, in a couple more years in when the forgiven amounts balloon, the issue may come to a more heated debate no matter who is in charge. Because the overall student loan situation, PSLF or not, is untenable, unsustainable, and rapidly robbing young Americans (and thus the future of our country) of their chance at economic prosperity. Something has got to give.

But to give you an idea of how not imminent this is, keep in mind the Republican congress passed a temporary expansion of the existing program to help people who didn’t read the fine print.

However, the long-term health of the program is irrelevant if you’re already in school. Because the changes, whenever they come, should not affect you.

Websites and news outlets love to play up PSLF-doom-stories because they make for great clickbait (and also encourage private refinancing referrals from which many of them profit). But the clear take-home message from both the MPN and political proposals is that it does not matter what happens to the program if you’ve already made the decision to borrow money for school based on the program’s existence. When people rely on a program, you can’t pull the rug out from underneath them (not just because it’s unfair, it’s actually illegal).

And, for the hyper-cynical among you, when Trump’s Department of Education tried to do so in a very limited fashion recently (by retroactively denying some lawyers who fell into a gray zone of non-501(c)(3) nonprofits that must be approved on a case-by-case basis), the courts shut them down pretty robustly. You can’t change the rules of the game if people are already playing.

PSLF is also a partial federal match for pretax retirement contributions

For those who qualify, PSLF can make an incredible difference in your long-term financial health by wiping away your student loans well before and for less money then you may be able to accomplish for yourself.

Due to the way income-driven repayment plan monthly payments are calculated, PSLF also acts as a government subsidy on your pretax retirement contributions. If you are currently using an income-driven repayment plan, every dollar you contribute this year to a pretax account will not only save you money on taxes this year (at your marginal tax rate) but will also “lower” your income for the year and then save you ten cents the following year.

Why?

Because IDR loan payments are calculated according to your discretionary income. Less income, smaller payments. For the two most common plans for recent borrowers, PAYE and REPAYE, it’s 10% (for borrowers on the old version of IBR, 15%).

For loans eventually forgiven via the PSLF program, every single dollar less you spend on your loans during the 10 years of repayment is another dollar that you save. This amounts to a partial federal match on your 401(k)/403(b)/traditional IRA contributions and an automatic 10% return on your investment.

Theoretically, the relatively low income of a resident is generally ideal for making post-tax Roth contributions (either to a Roth 401(k)/403(b) or Roth IRA). This is because doctors are felt to likely want to retire on more annual “income” than they earn as a resident, so that paying taxes now in a lower bracket is better than paying taxes later when in a higher bracket (not to mention the possibility that tax brackets may be higher across the board in the future). That said, a life in retirement without constant car payments, a mortgage, or student loans would cost far less than a similar lifestyle as a young professional. The bonus “match” is a reason to consider making pretax contributions against the more conventional wisdom.

Note that even without PSLF, pretax contributions still reduce monthly payments. For people actually paying off their loans, lower payments generally aren’t a good thing (just more money spent in the long term on interest), but in the setting of REPAYE and negative amortization, the lower payments would also mean more unpaid interest and thus more unpaid interest waived via the 50% unpaid interest subsidy and a lower effective interest rate.

For example, if you were somehow able to max out your personal contribution ($19,000 in 2019), then you would reduce your payments by $1,900 the following year in PAYE/REPAYE (or $2850 in IBR). That’s $158 per month. And that kind of savings over 10 years definitely adds up.

Extending $0 payments

Things can get really creative. If you were lucky enough to have a working spouse who earns enough to pay for your family’s living expenses (or are so hyper frugal that you live in the call room and eat saltine crackers pilfered from the ER for the majority of your meals), you could even pull a clever trick and zero out your loan payments for your first two years of residency. How?

Well, if you read my beloved (free) book, this helpful post about consolidating your loans after graduation, or remember the bit about this from a few paragraphs ago, you’d recall that payments under an IDR plan are calculated as 10% of your discretionary income based on last year‘s taxes under PAYE/REPAYE. A graduating medical student / new intern generally made little to no money the prior year and can secure zero dollar monthly payments for their intern year that nonetheless still qualify for PSLF.

Now here is where the retirement contribution component comes in. Normally, a second-year resident who consolidated after graduation will make payments based on a tax return that combines the last half of their fourth year of medical school and the first half of their internship. This means that it essentially based on a half year of income, say $25-30k instead of $50-60k.

Discretionary income takes your adjusted gross income and subtracts 150% of the poverty line. So PAYE = 10% (AGI – 150% x Poverty Line) / 12. For example, in the contiguous 48 states in 2019, the poverty line for a single person is $12,490. As a practical matter, this means that a single borrower must make around $19k per year in order to have a non-zero payment. Therefore, if you can put away enough money in the first half of your intern year to reduce your gross income to the poverty line, then your payments the following year will also be zero dollars.

(Note: it’s actually probably better to have a token payment of a few dollars so that there is an easier paper trail of payments for PSLF as well as no chance of your servicer not applying the 0.25% interest rate reduction for setting up auto-pay).

Roth conversions can be a useful hedge

Consider a Roth conversion to be a hedge. Now if a light bulb just went off and you’re thinking you could place money in a pretax 403b/401k to get the income-lowering benefits for IDR/PSLF purposes and then immediately convert that money to Roth in order to take long-term advantage of their low current income bracket, that’s not how it works. The IRS treats the Roth conversion amount as income for your taxes, so it undoes the income lowering.

But while in REPAYE, you could make pretax contributions during your early residency years as we discussed to get the lowest effective rate possible. Then, during your final training year—if you now know you’re not going for PSLF and have enough money saved up—do a Roth conversion and pay the taxes at your low resident income bracket before you become an attending. A senior resident and an intern are in the same tax bracket unless a lot of moonlighting is taking place, so you don’t lose money that way due to higher marginal taxes. In this setting, you’d likely follow this with a student loan private refinance, so the increased AGI for the following year wouldn’t matter.

Take Home

So, in addition to providing uncapped tax-free loan forgiveness, don’t forget that PSLF also functions as a government subsidy on your retirement accounts as well.

Once in IDR/IBR/PAYE/REPAYE, Always in IDR/IBR/PAYE/REPAYE

“I got married” or “My income went up” and “they MADE me change repayment plan because I didn’t qualify anymore.”

No no no. They cannot make you do this. You are never forced to leave a federal repayment plan once you have been accepted for it, ever (unless you are not making your payments or don’t submit your annual income certification).

When in an Income-Driven Repayment (IDR) plan like IBR, PAYE, or REPAYE, payments may change annually—but the plan does not. People are more aggressive in negotiating their cable bill than they are in dealing with student loans servicers! Switching the acronym of your payment plan not only capitalizes your accrued interest but can easily cost could thousands or even tens of thousands of dollars.

If you lose your personal financial hardship while enrolled in IBR or PAYE, your interest capitalizes, but you’re not kicked out of the plan, and you are not forced to choose a new plan. Because you “no longer qualify” for the plan, your payments are capped at the 10-year standard repayment amount. “No longer qualify” is deliberating confusing phrasing. Yes, at this point, if you were to freshly apply, you would not qualify and would not be accepted into the plan. But guess what? You’re not applying, you’re just recertifying your income to determine your monthly payment amount. It doesn’t matter if you get married or if you win the lottery. Your plan is your plan until you choose otherwise. You don’t need to “qualify” anymore: once in IBR, always in IBR. Once in PAYE, always in PAYE.

People are being told during their annual income recertification that they need to switch from IBR and PAYE to REPAYE once they lose a PFH, and that is incorrect. All switching does is unnecessarily subject borrowers to uncapped higher monthly payments. The problem is, once you’ve switched to REPAYE on this bad advice, you can’t switch back (because you don’t qualify, see what they did there?).

You can never tell if this is ignorance or malevolence, but given that this is generally coming from FedLoan in the context of borrowers planning for PSLF, a “mistake” like this that results in borrowers spending more per month and getting less forgiven does look pretty suspicious.

Bottom line: This is just wrong. If you file your forms on time and make your monthly payments, your plan will never change.

Don’t let anyone tell you otherwise.

FedLoans instructs borrowers to commit fraud

I keep hearing of cases of FedLoan Servicing providing blatantly false and dangerously misleading advice to borrowers when it comes to submitting their annual income recertification.

In fact, it’s so clearly wrong that I wondered if the people reporting it were simply mistaken or confused until I’d heard it repeated so many times. It concerns how to file your recertification when utilizing the Married Filing Separately “loophole” in IBR or PAYE.

The quick background: as you may know, federal student loan borrowers must submit their income annually in order to partake in any of the income-driven repayment plans including IBR, PAYE, and REPAYE. If the borrower is married and files their taxes jointly with their spouse (which is the common choice), then their family income is used to calculate their monthly payments. But if they file their taxes separately, then their payments under IBR or PAYE would be based on just their own income and ignore their spouses. This is considered a bit of a loophole, which is why the newest payment plan REPAYE takes into account household income regardless of tax filing status.

So here’s the fraud part. There’s generalized incompetence, and then there is this: FedLoan is actually telling borrowers who have correctly filed their taxes separately that in order to ignore spousal income–even in IBR or PAYE–that they need to check a box saying that they are “married but cannot reasonably access [their] spouse’s information.”

This is simply not true and does not follow any of the rules. What it does do is clearly misuse a niche box that was provided to help estranged spouses or sufferers of domestic violence.

In fact, this very kind of fraud was anticipated by commenters and addressed by the government, because some folks were worried that simply allowing for “self-certification” of spousal status would give people the chance to reopen the MFS loophole that REPAYE closed by simply pretending that they’re not really married.

From the Federal Register:

The commenter also suggested that borrowers who want to evade the requirement will not bother to have their spouse keep separate income information, but will falsely claim that they have no access to such information instead. According to the commenter, if the Department simply accepts such claims, some borrowers will unfairly benefit, and if the Department contests borrower claims that their spouse’s income information cannot be accessed, it will lead to controversies and lawsuits at great expense to taxpayers.

We note that the strategies suggested by the commenter who raised concerns that some borrowers might try to evade higher payments by hiding income or falsifying the certification form would be fraudulent. We expect that most borrowers would be deterred from falsifying information on a Federal application form by the significant penalties that can be applied.

So there you have it. FedLoans is–for absolutely no reason–essentially forcing borrowers to commit fraud in order to rightfully exclude spousal income. People have been submitting their annual recertifications incorrectly under this specific direction for years and repeatedly so, and FedLoan is apparently still giving this advice on a regular basis.

My personal advice (as an individual citizen who thinks fraud is a thing to be actively avoided) is to simply not follow whatever particular variant of this incorrect advice you receive from whatever random representative you speak to. Instead, ask for someone higher up to set things right. There are definitely people in the organization that know that this is incorrect, so don’t give in and do the wrong thing. I would hope that this practice will become universally known as the fault of the loan servicers and not your personal failing, but the risk isn’t worth it.

Now, if you file taxes jointly and think you are being clever by checking that box in order to lower your payments, don’t do that. That’s definitely unequivocally fraud.

In a broader context, this is just another example of why you should not get your loan advice from a loan servicer. They have no fiduciary duty to actually help you, have been and continue to be sued for being awful at doing just that, and the current administration has done everything in their power to remove all momentum in addressing this problem.

Read a (free) book. Scour the web. Talk to an advisor. Whatever. Just don’t trust a servicer at face value.