Because I was lucky enough to receive a scholarship and go to a low cost in-state university, I never had to deal with the bane of our generation, student loans. A lot of news outlets will throw around a $30,000 average balance, but many people who go to medical school, law school, business school, or other graduate program have 5 to 10 times that amount.
For those saddled with huge debt loads, it can delay big life decisions like buying a house, a car, getting married, and having children. Friends have shown me loan balances as high as $300,000, and I’ve heard of figures as high as $500,000. What can you do when loans are eating you alive?
The US government created one of the largest debt forgiveness programs in history in 2007 that will start taking effect in 2017. Thousands of graduates will get their student loans wiped off the books without any negative impact to their credit score or taxes. I want to make sure that you are aware of this provision so you can make plans accordingly because this rule upends everything that used to be true about salary negotiations, how to choose your employer, and the conventional wisdom on getting out of debt.
The Public Service Loan Forgiveness Program
The Public Service Loan Forgiveness Program (PSLF) is a major benefit that Congress enacted in 2007, but it by far the most generous. The basic provisions of the plan require you to work for 10 years for a non profit or governmental organization (political parties and labor unions don’t count), be enrolled in one of the official payment plans offered by the government for student loans (usually one based on your income), and after 120 qualified payments (12 payments a year times 10 years) you can apply to the government to have your debt forgiven tax free.
What I didn’t realize until taking a look at repayment plans for my girlfriend was that the definition of non profit or governmental organization is so broad that you could drive a truck through it. Basically any entity providing a service to the public that would be eligible to receive a tax deductible gift could qualify. So non-profit hospitals, local non-governmental organizations, and university endowment funds could be a few examples. I had heard of the PSLF program before, but I thought it was a strictly defined program where you could get some loan forgiveness if you were a meagerly paid public defender for the county government. Little did I expect that there is no cap for the amount that can be forgiven and that tens of millions of people could qualify for this benefit.
How PSLF is Far More Generous Than Other Forgiveness Options
So when you graduate you get a nice little letter in the mail detailing your student loans. Your financial aid office might sit down with you one day and explain the different options for making payments on your monster load of debt. Since you can’t afford the 10 Year Standard Repayment Plan where you’d try and make the massive payments necessary to be done in 10 years, you will probably sign up for one of the income based payment options.
The most popular of these payment plans are Income Based Repayment (IBR) and Pay as You Earn (PAYE). The first limits your loan payments to 15% of your discretionary income, the second limits your loan payments to 10% of your discretionary income. The Feds figure out what that amount should be by taking your total income, subtracting 150% of the federal poverty line, and multiplying that number by the appropriate amount. For example, if you worked for a non profit in Washington DC that paid $50,000 a year, they would take (50,000-17,655) * 0.15 and tell you that you owe $4,871.75 a year, where $17,655 is 150% of the poverty line for the lower 48 states. If you have a large debt load, that payment will not pay all of the interest, so the figure will continue to grow during the time you are making these limited payments from a low income.
The different types of repayment plans apply to everyone regardless of your employer. The difference is what benefits you get from making these payments. If you are working for a for profit employer, you are not eligible for PSLF. After 25 years of making income based payments on your student loans, if you have not been paying down the balance, the total sum owed will be really large! The good news is that everyone qualifies for loan forgiveness after 25 years on the IBR plan or 20 years on the PAYE plan. BUT WAIT! The forgiveness is not the same as it is for the PSLF program.
When you make loan payments for 20-25 years, if you’ve worked in the for profit sector the entire time, the amount forgiven will be considered taxable income. For very large balances, you could be in the highest tax bracket and owe 40% or more of the outstanding balance as a debt to the IRS. It’s not clear to me what would happen when the amount is unpayable because it’s so huge. I imagine you would have to work out a settlement with the IRS, potentially affecting your credit and forcing you to make installment payments.
For new borrowers looking to go for the PSLF option, you should probably choose the PAYE plan to limit payments to 10% of discretionary income. So say that the DC nonprofit worker from earlier in the post had $200,000 of student loans. His income based payments would not cover the interest, so the debt over 10 years time would swell to over $300,000.
Since such a small percent of student loan interest is deductible, if you were to attempt to pay this sum back you would need to earn more than the amount due since you have to pay taxes first before making debt payments. If you are in a 20% tax bracket, over 10 years this is equivalent to getting ( $300,000 / 10 ) / (1 – 0.2) = $36,000 a year in extra income. So what sounds better to you, working for a non profit with lots of vacation, a relaxed work environment, and nice colleagues all trying to make a difference on that $50,000 salary, or finding a $86,000 job with less vacation, business formal dress code, and cutthroat coworkers? The larger your debt load, the more attractive a career in public service is.
Will the Moral Hazard from the PSLF Program Cause Congress to Change the Rules?
Because there are no limits to the forgivable amount, you could max out your loans in undergrad every single year at the most expensive college in the nation, go to medical school, get a master’s degree, and get the entire figure wiped away for 10 year service. The PSLF program is so good, the for profit sector is now at a huge disadvantage in hiring college educated workers. The full impact of this program on the labor market is a few years away from being felt, because the first people eligible for this program will start getting their loans forgiven in October 2017.
I don’t think Congress intended to forgive unlimited amounts of debt when they enacted this massive overhaul in 2007. Or perhaps they did, but they figured they would not be around to have to pay for it in 2017. I suspect future Congresses will go back and make modifications to the program. Compared to the options available for workers in the private sector, this forgiveness plan is so good it can’t last forever. Once the media publishes a few stories on graduates who used PSLF to get two master’s degrees for free, I think there will be some political pressure to cap the amount that can be forgiven. However, I think that the individuals who started off with this set of rules will be allowed to finish with the same set of rules.
Extreme Examples of The Generosity of PSLF and How It Should Affect Who You Work For
Consider a medical school graduate, who we will call Dylan, who chooses neurosurgery as a specialty. Let’s say Dylan went to an elite private liberal arts college in the Northeast. Because his family made too much money to qualify for need based financial aid, but his family was too cheap to help him out financially, he racked up $100,000 of debt in undergrad. Now he gets into Johns Hopkins, one of the best medical schools anywhere in the world. Let’s say he adds another $300,000 in debt while getting through med school and finishes as a new doctor with $400,000 in total student loan debt. The average resident might make around $60,000, so there’s no hope that Dylan could even make the interest payments at a rate of 6.8%, a common figure for student loans right now. The interest charges alone would be more than half his take home pay. So he signs up for the Pay As You Earn plan, which limits his payments to no more than 10% of his discretionary income, defined as 150% of the poverty line where he lives. So maybe he makes $4,000 a year in payments while he’s earning a low income and the remaining $23,200 gets added onto the total balance yearly. Since Neurosurgery residencies take seven years and fellowships can take a few years as well, this period of small payments will last for 10 years during his training period.
This is how his student loan balance would grow:
So at the end of the fellowship, he would owe over $675,000. While neurosurgeons make a ton of money, that’s a huge amount no matter who you are. So now the fun part. Whether Dylan now applies for tax free loan forgiveness or continues making payments on this massive debt depends on what kind of hospital he worked at for these 10 years.
If he worked at a non profit hospital, defined as a 501c3, or the kind where rich people name parts of the building after themselves and go to galas with silent auctions, then he can apply for through the PSLF program and the entire $675,000 is forgiven, TAX FREE!
If that residency and fellowship was instead at a for profit institution, like one of the many hospitals owned and operated by the Hospital Corporation of America, a for profit company, he still owes that $675,000. Even though he is performing the same service and working in the same capacity, the tax filing status of his employer just decided whether or not he qualifies for 3 Ferraris worth of loan forgiveness.
If Dylan had to pay back this $675,000, how would that affect how much more he would have to make in income? Since neurosurgeons are in the top tax bracket and have to deal with things like disability and malpractice insurance, let’s assume Dylan gets to keep 50% of what he makes, a charitable assumption given how high insurance rates are and that he will be losing at least 40% to taxes. Say he makes $1 million starting salary, which is highly unrealistic for a starting surgeon but I just want to assume something super high to make the point.
He takes home $500,000 a year in this scenario. The interest alone on his debt is over $45,000, so say he pays the interest plus around $50,000 a year, a figure representing about 20% of his take home pay in the beginning.
It takes him 15 years to pay off his debt with this very high payment amount (!!!) During these 15 years, he has paid a total of over $1,000,000. This scenario is if he makes an unrealistic $1,000,000 starting salary at the beginning of his career as well. Since most neurosurgeons start practicing in their mid 30s, Dylan can expect to be debt free in his early 50s. If he’s lucky, he could have a full 10 years to enjoy the higher income benefits that come with working in private practice or a for profit hospital before he retires. To make him indifferent between employers with private or non profit affiliations, he would have to make over $150,000 a year more to work in the private sector.
So what if Dylan studied a low paying specialty like family medicine and joined a private practice instead? He would have been stuck with that high debt load for 20-25 years and had a giant tax bill right as he was trying to find the money to save for retirement. These new debt forgiveness rules have totally changed the rules of the game.
Action Steps You Need to Take Right Now For Your Student Loans
If there’s any chance you have employment history that might qualify as “public service,” and the definition is so broad it’s worth checking out to see, you should submit this form to the government right away. They will let you know if your employment history and payments qualify for this amazing loan forgiveness program.
If for some reason you do not qualify, they will tell you why. You might also want to hire student loan help to get a plan in place for you that saves as much money as possible. That’s why I think everyone with student loans should submit this form to the government to see if they’re on track for a massive windfall. If your employer doesn’t qualify, most people with high debt loads should consider negotiating significantly higher salaries with their private sector employers. If your employer will not do that, then you might want to seek a job that would qualify for PSLF.
Another HUGE caveat is this forgiveness program only applies to direct subsidized and unsubsidized loans from the US Government. If you took out Perkins loans or signed up for a non-governmental loan through the Federal Family Education Loan Program, you can make income based repayments on the balance BUT IT PROBABLY WON’T COUNT TOWARDS THE 10 YEARS YOU NEED TO GET THE DEBT FORGIVEN UNDER THE PSLF PROGRAM! If you’re just now getting a job or plan on a long term career in the public sector you can consolidate these loans into a direct consolidation loan from the government that WILL be forgivable. Regardless of your situation, submit the certification form I gave the link to above and then try and get a live human being on the phone, preferably from the Federal Financial Aid Office.
Ask several different people working for different employers (ie your school’s financial aid office) and make absolutely sure you’re hearing the same thing. Not to knock financial aid people, but they are poorly paid, and in any job where you’re dealing with lots of complexity for low pay, you are going to get variability in the competence of the employee. If you have questions, post them in the comments below and we can see what kind of info we can find if you have questions.
If debt has got your down, you needn’t worry. There are always ways to save and survive financially. Thanks to the this PSLF program, you could even get the equivalent of a $1 million+ inheritance from your rich Uncle Sam. You don’t automatically get this inheritance though. After 10 years of qualified work, you must file and claim your benefit. If you aren’t in this situation, but know a friend that is, please have them read this article. At the very least email them the free PSLF form so they can see if they could qualify for this extremely generous government program. If you show them how to get student loans forgiven tax free, they will love you forever.
Have you experienced higher competition for PSLF eligible jobs? Ever used the PSLF program as ammo while negotiating for a higher salary with a private employer? Want to share your opinion on the PSLF program and if you think it will continue? Comment below!