Maximizing The Value Of Public Service Loan Forgiveness (PSLF) By Minimizing Debt Repayment
In an effort to make college more accessible to low-income students, the Public Service Loan Forgiveness (PSLF) program was created in 2007 with the intent of offering tax-free forgiveness of certain student loan debt for borrowers working in qualifying government or non-profit jobs for at least ten years. However, in the decade-plus since, the scope of the program has expanded as the skyrocketing cost of education has left record levels of college graduates with a debt load that is very difficult (or outright impossible) for them to repay, leaving PSLF as an appealing route for them to eliminate their student loan debt as well as work towards other financial goals.
Yet, the requirements to qualify for PSLF are fairly stringent, and in this guest post, Ryan Frailich, founder of Deliberate Finances (a fee-only financial planning practice that specializes in working with couples in their 30’s), discusses the rules around PSLF, PSLF’s unique advantages (and disadvantages), and the opportunities that financial advisors have to help clients minimize overall payments by managing their annual Adjusted Gross Income (AGI).
To qualify, PSLF candidates must work full-time for a qualifying government or non-profit employer and have Direct Federal loans (which can include Direct Subsidized, Direct Unsubsidized, Direct PLUS, or Direct Consolidation loans). The borrower must also be in one of four “Income-Driven Repayment” plans, consisting of Income-Based Repayment (IBR), Pay As You Earn (PAYE), Revised Pay As You Earn (REPAYE), or Income-Contingent Repayment (ICR) plans, which all calculate monthly loan payments based on the borrower’s AGI. Thus, rather than having fixed payment obligations determined by loan term, balance, and interest rate, a student loan borrower’s payments will adjust in step with their AGI instead.
And because these PSLF-qualified income-driven repayment plans depend on AGI, financial planners have the opportunity to help borrowers minimize payments by reducing AGI in every manner possible… to maximize the value of forgiveness at the end of the 10-year repayment term. While every client’s situation is unique, some common strategies include: using Married Filing Separately (MFS) instead of MFJ as a tax status for married borrowers, maximizing qualified retirement account contributions, and utilizing employee benefits to offset W-2 wages of the borrower pursuing PSLF. Accordingly, these (and other) strategies can offer significant savings to the borrower in the long-term by reducing debt obligations that would otherwise be much higher under a standard repayment plan (and all without necessarily reducing overall income!).
PSLF has significant advantages over other programs for Federal student loan forgiveness. For income-driven repayment plans, the time to loan forgiveness is generally 20 to 25 years (versus the much shorter 10-year PSLF requirement), so the borrower who qualifies for PSLF will pay less in total student loan interest along the way. Additionally, the amount forgiven by other Federal student loan repayment plans is counted as taxable income, unlike the tax-free forgiveness offered by PSLF. Which means that, because many borrowers on income-driven repayment plans have loans negatively amortizing (i.e., the loan balance grows each month), without PSLF they may end up with debt forgiveness that is multiples more than the debt originally taken out, resulting in a tax burden that can negate much of the impact of loan forgiveness in the first place.
Ultimately, the key point is that the PSLF program can be an effective tool for borrowers managing overwhelming student loan debt, and because loan payments qualifying for PSLF can change dynamically based on income (versus a fixed monthly payment based on initial loan balance and interest rate), financial planners can help clients maximize the amount of the loan ultimately forgiven by using strategies to minimize AGI every year during the loan repayment years… which, for some borrowers, can equate to hundreds of thousands of dollars in savings (assuming all PSLF requirements are met)!