Brandon Carter, CFP®, CIMA®, ChFC®, AEP®, MSFS
There is no question that student loans are a major economic burden on those holding them. Thankfully there are programs available to offer relief and even forgiveness for some student loans. There are some great resources online that describe how the loan forgiveness process works but not a lot of info describing planning strategies. The focus of this article will be the income-based repayment plans through the Public Service Loan Forgiveness Program (PSLF).
Specifically, we will discuss a couple strategies to help those who qualify for the program get the most out of it. In other words, help them increase the amount of loans that are ultimately forgiven. (For related reading, see: Debt Forgiveness: Escape Your Student Loans.)
Basics of Public Service Loan Forgiveness
The Public Service Loan Forgiveness Program was designed to help those burdened with student loans who choose to work for a public service organization for at least 10 years. Those who qualify for PSLF are given a mandatory monthly payment that is adjusted annually (based on “discretionary income”). If they remain employed by a qualified public service employer and make these mandatory payments for 10 years (120 months) the remaining balance on their qualifying student loans will be forgiven at the end of the 10 years. The amount forgiven can be very significant as it is possible for the mandatory monthly payment amount to be significantly less than the regular student loan payment or even zero. You can get information on who qualifies for and what loans are eligible for PSLF on the Student Federal Aid site.
The key to understanding strategies for reducing the mandatory monthly payment is to understand how the monthly payment is calculated. Your mandatory payment is based on your “discretionary income” and there are three main factors that determine what your discretionary income is. Your adjusted gross income (AGI), the amount you owe on your student loans, and the size of your family. If you have large loans and a low income you are deemed to have a low discretionary income and therefore will have a low or no mandatory payment. If your loans are small and you make a six-figure income your payment plan will be larger and your loan may be paid off prior to the 10 years, making loan forgiveness unnecessary.
Additionally, the larger your family the lower your payment. Everything else being equal a family of five will have a lower payment than a family of two. There are several formulas that can be used to calculate the monthly payment. Covering the specifics of each is outside the scope of this article but these are the three main factors for all the calculation methods.
Below are a few strategies you can implement to get the most out of PSLF:
Consolidate Student Loans
Some loans do not qualify for PSLF but can be consolidated into a direct consolidation loan that does qualify for loan forgiveness. By increasing the size of qualifying loans you increase the amount of your loans that can be forgiven. Carefully consider consolidation before moving forward though. There are several reasons you may not want to consolidate including losing benefits on your current loan or increasing your interest rate. This may not be a huge deal if your loans are going to be forgiven but what happens if you don’t end up working for a qualified employer for the full 10 years?
Reduce your Adjusted Gross Income
- Max out any employer-sponsored retirement plan (401(k), 403(b), etc.) contributions. This is my favorite strategy. By maxing out, or increasing, your retirement plan contributions you not only decrease your AGI, thereby reducing your mandatory payment, you also are saving for the future and possibly taking advantage of company matching! What more could you ask for? You may also want to consider increasing contributions to traditional IRAs (as long as you are able to deduct the contribution) and Health Savings Accounts (HSAs) as these contributions will also reduce your AGI.
- Consider your tax filing status – If you are married it may make sense for you to file your tax return married but filing separately. The reason for this is that your spouse’s income is included in determining your discretionary income if you file jointly. If you file separately and state that you don’t have access to your spouse’s tax return your spouse’s income will not be considered. Filing separately can make a lot of sense, particularly if your spouse has a healthy income. As with so many other things there are some major disadvantages to filing separately including the loss of certain deductions and credits. I would highly recommend you meet with a CPA to help you weigh the benefits and disadvantages. Most CPAs will have software that will help them analyze what is best for you.
Increase the Size of Your Family
I know this may not be a goal for everyone however it really does assist with this program. While it may not make sense to adopt or have a child just to decrease the amount of your loan repayment, if you are already considering it this would be a little icing on the cake.
The PSLF program is a great opportunity for those who qualify and an even better opportunity for those who implement some planning strategies. As you can see, the PSLF program is complicated and trying to make the most of it can be a daunting task. That is why I highly recommend working with a financial planner and tax advisor who understand the program. The fees you pay to these individuals are often minor compared to the savings they will help you gain. (For more from this author, see: Top 3 Mistakes Retirees Make With Their Finances.)
The commentary in this article reflects the personal opinions, viewpoints and analyses of Brandon Carter, and should not be regarded as a description of advisory services provided by Financial Strategies Group, INC or performance returns of any Financial Strategies Group, INC Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing in this article constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Financial Strategies Group, INC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.