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It has been 10 years since the first Income-Based Repayment (IBR) plan for federal student loans was introduced. Today, there are alternative IBR based plans such as Pay As You Earn (PAYE) and the Revised Pay As You Earn (REPAYE), each with its benefits and drawbacks. Some people are in one of these plans, others are not, and others are thinking about enrolling. For those who are in it, some will stay on until the outstanding balances are forgiven after 20-25 years. Others have later decided to pay the loans in full and have refinanced their loans to get a lower interest rate.
Those who recently enrolled or are thinking about enrolling have many questions about what they should do for the first few years. Most of the questions involve how to minimize payments, maximize loan forgiveness, and live a comfortable lifestyle while doing so. Over the years, I have talked to and worked with people who have been on these plans, some since 2009. Today, I will share some advice based on their experiences.
Almost every person I talked to said that the first 10 years should be focused on developing your career. In other words, do not choose a job based on how it will affect your monthly student loan payments. This is because the career path of a young lawyer will be unpredictable. Many lawyers do not get their ideal job immediately after graduation and are likely to switch firms, practices, and even careers. And most young lawyers are unmarried and do not own a home which makes them more flexible with their career options. Once their career path stabilizes, they can determine whether they will be able to pay off the loan in full or need to stay on an IBR plan until the loans are forgiven.
Similarly, don’t worry too much about the tax consequences of forgiven student loan debt for now. Many people contact me after they see how much income tax they will potentially owe when their loans are forgiven. This is because most forgiven student loan debt is considered cancellation of debt income to the government unless you can show insolvency. Only those who are enrolled in the Public Service Loan Forgiveness program are exempt from cancellation of debt income treatment.
They are worried that they will have to sell their house and cash out their retirement savings to pay the potential tax. Or they fear having to live a squalid lifestyle for 20 years in order to qualify for the insolvency exception.
The above dire outcomes are possible. However, 20-25 years is plenty of time to plan for minimizing the tax bomb. Businesses can be restructured, and assets can be transferred tax-free with the proper estate plan. And maybe, just maybe in a few years, Congress will pass a law that will exclude forgiven student loan debt from taxable income. Assuming that the number of eligible voters in an IBR program increases every year, a change in the law is very likely, if not inevitable.
If feasible, enroll in an IBR plan as soon as possible, even if you can afford to make the payments under a standard payment plan. The purpose is to start the loan forgiveness period. Supposedly a recession is coming, so there is a chance of being laid off or moving to a job that pays less than what you currently make. IBR plans set up a minimum payment amount but enrollees can increase their payments or save it and pay later.
Also, before making major life decisions, get advice from professionals to minimize payments and asset accumulation. For example, purchasing a home will create an asset which will be considered in an insolvency determination. If you get a mortgage, you may have no equity in it now, but you will in 10-20 years. If you purchase a home, you should have a plan to transfer the house before the loan forgiveness date. Also, if you are getting married, consider whether it is best to file separately or jointly. You may have to pay more tax filing separately, but the smaller student loan payments can offset this.
So in general, those who recently started an IBR program should have a general idea of how to determine their monthly loan payments and how to minimize cancellation of debt income. But they should spend the first 10 years focusing on their career goals instead of worrying about whether a job will increase their monthly loan payments. With proper planning and guidance, most people should be able to minimize their student loan payments while having a lucrative, satisfying career. After 10 years, a person should have a set career path and can reasonably project how much money they will make in the future. At that point, more detailed and customized IBR planning will be appropriate.
Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolve tax disputes. He is also sympathetic to people with large student loans. He can be reached via email at sachimalbe@excite.com. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.
Income-Based Repayment Planning: The First 10 Years curated from Above the Law
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