Student Loans: Smart strategies for public service loan forgiveness
This is the second of two posts on the powerful repayment plan we made this year for our student loans. Read the first installment (on our private student loan debt) here.
My husband and I have established a "Divided and Conquer" strategy to paying off our student loan debt:
- We have made an aggressive plan to pay down our private student loans; and
- We are currently planning to eliminate our federal student loans through public service loan forgiveness.
This post is about the strategy we're using to keep our federal loan payments low while we focus all our extra dollars on eliminating other debt.
Since I began writing this two-part series, the program that we have been relying on when making professional and financial decisions -- Public Service Loan Forgiveness -- has been proposed for elimination to make way for charter school funding and school vouchers in the budget proposed by the Trump Administration. While Congress wields the "power of the purse" and will ultimately determine the future of this and other public education programs, anyone who is planning to utilize public service loan forgiveness should have a backup plan in their back pocket.
A little background on our federal student loans...
With a notable sum of loans between the two of us, Public Service Loan Forgiveness has been appealing to us since we graduated. Loan forgiveness allows full-time employees in certain non-profit or government positions to use a student loan payment plan based on their income for ten years. At the end of that ten years, any remaining federal student loan balances will be waived in return for public service (e.g., work in traditionally lesser paying government/non-profit jobs). Loan forgiveness requires full-time work and on-time payments. It isn't offered on private student loans.
Last year, we did a massive amount of paperwork and applied for an income-based repayment plan based on these facts:
- My husband and I are both somewhat recent graduates who deeply enjoy our qualified public service jobs.
- We are highly likely to continue this work full-time for at least the next ten years.
- Our federal loans are eligible for Public Service Loan Forgiveness.
Being strategic about public service loan forgiveness
When we set up our loans for income based repayment last year, we immediately began saving over $500 per month which helped us start aggressively paying off consumer debt like credit cards and car loans. As relieved as I was at the time, I didn't put a whole lotta extra thought into our student loan repayment strategy at that time. I hadn't considered when I set up this plan was how we could keep our income-based payments as low as possible.
Updating our strategy.
The federal government uses our adjusted gross income to determine the amount of our student loan payment. Under our repayment plan, we pay 10% of all of our income that exceeds the baseline amount of money that the government thinks we need for our household to survive. This means that any actions we take to reduce our adjusted gross income (or AGI) will also further reduce our student loan payments throughout the year.
The surprising link between retirement savings & our student loans.
Last year when we started this journey, we didn't plan to begin making investments or setting aside additional retirement saving because we wanted to focus first on eliminating debt. I currently contribute almost 10% to a government pension and my husband makes modest contributions to a 403(b) retirement plan that has no employer match.
In a couple years when our debt was squared off, we planned to make additional retirement contributions to a Roth IRA that would allow us some security while also serving as a last resort emergency fund. This plan changed completely when I realized that any retirement contributions to a Traditional IRA over the next then years would reduce our student loan payments as well as our taxes. (I'm gonna dive into some numbers here--Stay with me!)
How retirement contributions would lower our student loan payments.
Payments to some kinds of retirement plans (Including Traditional IRAs), lower adjusted gross income. Since we basically pay 10% of our adjusted gross income toward our federal student loans, any money we put into a Traditional IRA will reduce the amount we pay on student loan payments in the following year.
Here's an example:
Traditional IRA Payments = $5,500
Adjusted Gross Income Goes Down = $5,500
Student Loan Payment Reduced = $550 over the course of the year
(10% of the difference in our AGI)
You can see that any contribution to a Traditional IRA will save us money on the following year's student loan payments. Combined with not having to pay 25% in taxes on these contributions, this means that roughly 35% of the money we put into a Traditional IRA would be free money.
Here's another way to look at those numbers:
Money paid into Traditional IRA: $5,500
Money saved on taxes (25%): $1,375
Money saved on student loan repayment (10%): $550
Actual cost of $5,500 in IRA contributions: $3,575
While we may not be able to max out IRAs right now, these numbers were enough to convince us that we need to begin making contributions to a Traditional IRA in 2017. When we do, we'll be using a super low fee Vanguard IRA. Like most Americans, we probably should've started making these contributions a lot sooner. (No. 1 Financial Regret of Older Americans: Not Saving For Retirement Early Enough via MarketWatch)
Anyone using an income-based loan repayment plan (anyone paying income tax really!) should be sure that they are thinking strategically about their Adjusted Gross Income (AGI) when making financial decisions. Retirement contributions are not the only way to lower AGI. Itemizing our deductions has meant that we've always gotten credit for our charitable contributions. We'll just be more concientious of impacts to our AGI when making financial decisions as we go forward.
A HUGE IMPORTANT SIDE NOTE: While this strategy works best for our current plan of action, choosing an income-based repayment plan could hurt us later if we decide we'd like to pursue pay off our federal student loans quickly instead of continuing on the path of public service loan forgiveness (or if Public Service Loan Forgiveness is terminated by El Presidente). Any payment that is lower than standard means extra interest accruing after all.
What's next for our Student Loan Debt.
Part of achieving financial freedom is increasing earnings. With this goal in mind, my husband is applying for graduate school. Even though he is looking at low-priced public schools with good reputations, this will likely lead to more student loan debt. It will also immediately open up a wider variety of opportunities for him in a crowded job market. Graduate school will give him the opportunity to continue doing work that is deeply rewarding while potentially doubling his income in the years ahead.
We've set an ambitious goal for our private student loans and an income-based repayment strategy for our federal loans... we hope to continue with these payoff plans while he attends school.
Nothing has made me feel more like a financial novice than our student loan debt. Because of this, we'll continue learning more this topic. Once our private student loan debt is eliminated, we'll re-evaluate our plan and see if public service loan forgiveness is still the best path for our lower-interest federal loans.