Mega-Deduct and Convert: Save Thousands On Roth IRA Contributions

Mega-Deduct and Convert: Save Thousands On Roth IRA Contributions

This article from the Finance Buff explains a great way to save hundreds on Roth IRA contributions.

But I wanted to expand upon this idea and highlight an even bigger way to save using a similar strategy. Thanks to changes in tax law, the “deduct and convert” strategy has become much more beneficial. Before you read on, if you’re pre-retirement age, you must reside in Illinois or Kentucky for it to work well. For all Kentucky and Illinois residents, pay close attention!

The Original Strategy

This strategy exists thanks to Kentucky and Illinois favorable IRA rules. Both states allow state income tax deductions on IRA distributions (including Roth conversions) up to state specific limits. They also allow state income tax deductions on qualified Traditional IRA contributions.

The strategy involves contributing to a traditional IRA, taking the tax deduction (assuming you qualify), and then converting it to a Roth IRA. Kentucky has a progressive state income tax which ranges from 2% to 6%. Most people are paying closer to the top.

For example, in Kentucky if you contribute to an IRA and qualify for the deduction, you’re able to deduct the contribution for state income taxes. So no state income tax going in. You’re also able to convert Traditional IRA’s to Roth (aka Roth conversion) at any age and avoid Kentucky income tax on the converted amount. So no state income tax on a conversion to a Roth IRA.

By taking the extra step, you avoid state income tax on the Roth IRA contribution. For someone in the top KY tax bracket, this strategy effectively saves them 6% on the contribution amount when compared to contributing directly to a Roth IRA. For a $5,500 contribution, that’s $330 in tax savings. With two IRA’s maxed out at $11,000, the max household benefit would be $660.

Although $660 is better than a poke in the eye, it may not be worth the hassle to many taxpayers. And most don’t even qualify in the first place because they don’t live in Kentucky or Illinois and/or cannot deduct IRA’s. We’re talking about a small benefit for a small group.

However, since the article was written, new laws now allow 401k’s to offer in-plan Roth conversion. This effectively opens up the strategy to 401k participants and raises the stakes with much higher contribution limits!

Mega-Deduct And Convert

Greg and Jane live in Kentucky and plan to maximize Roth 401k’s in 2017 ($18,000 each) for a total household contribution $36,000. Instead, they contribute $36,000 to traditional pre-tax 401k’s and in the same tax year convert $36,000 to a Roth 401k. The Traditional 401k contribution is pre-federal and state income tax. The Roth conversion causes additional federal income tax but avoids state income tax. Basically, the federal income tax offsets and ends up the same as if they had contributed directly to Roth. However, they save 6% in state income tax by taking the extra step thanks to the favorable Kentucky IRA tax laws. This saves them $2,160 of state income tax. Now we’re talking about a pretty serious benefit.

The net effect for Kentuckians is a 6% boost on Roth 401k contributions (3% for Illinois). This works especially well for those already planning to contribute to Roth 401k. However in reality, most people aren’t 100% certain that the Roth is better than simply going with the traditional 401k. There are several additional factors to consider as detailed in this article by Michael Kitces on making the Roth vs Traditional decisions. Also, there is also the fact that state income taxes are potentially deductible if you itemize deductions. If this is the case, the effect of this benefit will be reduced based on the tax savings of the deduction.

There’s also the step transaction doctrine to consider. This IRS catch-all rule says you cannot take multiple steps to circumvent the rules. This might be viewed as a violation under audit. Therefore, because of this and because in reality most people aren’t sure if the Roth is actually best (even with potential for up to 6% boost), an even better strategy would be to go ahead and contribute to the traditional 401k. Wait and see how the year shakes out. And decide on the Roth Conversion at the end of the year. Doing this actually gives you a much better idea of what your marginal tax bracket will be which factors heavily into the decision. This allows you to make the decision based on the maximum amount of information. It also lessens the chance of it being considered a violation of the step transaction doctrine.

As with any potentially taxable transaction, you should ultimately consult your tax advisor before moving forward.

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© Wrenne Financial Planning | Crafted by Harris & Ward

Wrenne Financial Planning LLC (“WFP”) is a registered investment adviser offering advisory services in the State of KY, TX, TN and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. The presence of this website on the Internet shall not be directly or indirectly interpreted as a solicitation of investment advisory services to persons of another jurisdiction unless otherwise permitted by statute. Follow-up or individualized responses to consumers in a particular state by WFP in the rendering of personalized investment advice for compensation shall not be made without our first complying with jurisdiction requirements or pursuant an applicable state exemption.

All written content on this site is for information purposes only. Opinions expressed herein are solely those of WFP, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.

PSLF Lawsuits and Why You Can’t Rely On Servicers for Good Student Loan Advice

PSLF Lawsuits and Why You Can’t Rely On Servicers for Good Student Loan Advice

October of 2017 will mark the first year for borrowers to become eligible for loan cancellation through the Public Service Loan Forgiveness (PSLF) program. This program promises tax-free forgiveness to borrowers who make 120 qualifying payments while working for certain employers — generally either for the government or a non-profit organization. Unfortunately, it is becoming clear that the number of those expecting forgiveness is much greater than those who will actually see their loans cancelled later this year.

As borrowers begin to apply for forgiveness, many are finding that they were never eligible, despite previously being approved by their loan servicers. Given the way various payment plans are structured, this means that many people will have a higher balance today than when they entered into repayment, with no relief in sight. As a result, many are filing suit against the Department of Education, as well as servicers like Navient who previously informed borrowers that they were approved. If their claims are accurate, this would understandably create some concern from those counting on their loans being forgiven.

Despite what many are considering a broken promise by the DoE, it appears as though those at the heart of the lawsuit weren’t ever eligible for forgiveness. In order to be eligible for PSLF, you must follow these three criteria:

  • Eligible Loans – Specifically, FFEL loans are not eligible
  • Eligible Repayment Plan – IBR, RePAYE, or PAYE are the most common. Graduated, or extended plans, while sometimes resembling income driven repayment plans, do not qualify.
  • Eligible Employer – generally a government or 501(c)(3) organization.

The biggest source of confusion seems to be the eligible employer criteria, as the tax-exempt status of many organizations can be confusing. In fact, the American Bar Association — which is one of the employers in question in the suit — is considered a 501(c), which can be confusing to even the most savvy of borrowers. If you are unsure of the tax exempt status of your employer, you can look it up online.

While being sure up-front about your eligibility for forgiveness is ideal, this situation also could have been prevented if the servicers hadn’t initially “approved” these borrowers. The key takeaway here is that the loan servicers do not work for the borrower – they work for the lender. As a result, they are not a viable option for seeking counsel on your loans. In fact, it may be the opposite, per Navient executive Jack Remondi — “There is no expectation that the servicer will act in the best interest of the consumer.

It is important to be fully aware of your options, as well as being confident that the one you have selected is best for you and your repayment strategy. If not done properly, it can cost you big time. And with many graduating medical students holding loans in excess of $300,000, it pays to be proactive.

If you have questions or would like to discuss your student loans, you can schedule a free consultation with us here. You might also find some valuable information in our Complete Guide to Student Loans.

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© Wrenne Financial Planning | Crafted by Harris & Ward

Wrenne Financial Planning LLC (“WFP”) is a registered investment adviser offering advisory services in the State of KY, TX, TN and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. The presence of this website on the Internet shall not be directly or indirectly interpreted as a solicitation of investment advisory services to persons of another jurisdiction unless otherwise permitted by statute. Follow-up or individualized responses to consumers in a particular state by WFP in the rendering of personalized investment advice for compensation shall not be made without our first complying with jurisdiction requirements or pursuant an applicable state exemption.

All written content on this site is for information purposes only. Opinions expressed herein are solely those of WFP, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.

Student Loan Perks Designed to Recruit Physicians Can Actually Hurt Them

Student Loan Perks Designed to Recruit Physicians Can Actually Hurt Them

Many physicians entering practice today owe more than $200,000 on their federal student loans. It’s become a major priority to address these massive loans as they enter into practice.

As a result, hospitals are introducing physician loan repayment perks for new hires to drive recruitment. However, confusing intricacies with the new Public Service Loan Forgiveness program “PSLF” are causing major unintended consequences.

Here’s how the typical physician loan repayment perk goes:

Dr. Smith is finishing training and owes $400,000 on his student loans. He signs on with a hospital for three years of employment and, in exchange, the hospital will pay $75,000 toward his student loan balance. The hospital pays the $75,000 directly to the loan servicer in one, lump-sum payment (or sometimes spread out over three annual payments). If Dr. Smith breaks his contract early, he must repay some or all of the stipend.

At first glance, it’s a win win. The hospital wins by getting Dr. Smith to sign on. Dr. Smith wins by receiving help with his massive student loans.

PSLF Game-Changer

Public Service Loan Forgiveness “PSLF” totally changes the game. Physicians who have qualified loans and are employed (full-time) by a qualified employer and make 120 qualified payments can receive tax-free forgiveness of any remaining balance (after they successfully prove everything was “qualified”).

Qualified loans are federal direct student loans – these are by far the most common type of student loans young physicians take out for medical school. If they happen to be federal non-direct, there are methods to change them into direct to make them “qualified”.

Government, 501(c)3, AmeriCorps, Peace Corps and other qualifying public service employers are considered qualified employers. The majority of hospitals (and residency programs) in the US fall into this category.

A qualified payment is a successful payment made to any qualified loan under any of the income-driven repayment plans or the 10 year standard repayment plan while employed by a qualified employer. These income-driven payments are exactly what they sound like – payments set based on income. Lower income equals lower payments and under most plans, there is a payment cap.

Maneuvering PSLF

Any medical resident with any wherewithal will rack up low PSLF qualifying payments and set themselves up to receive massive PSLF benefits if they end up with a qualified employer. The value builds during residency and remains even if the new physician scores an extremely high-paying job. It’s not uncommon for us to see physicians making mid six-figure salaries on track to receive tax-free six-figure PSLF forgiveness.

PSLF makes student loans unlike any normal debt. With normal debts, the more you pay, the less you end up paying back. Extra payments to principal are great because you save interest. With PSLF, the less you pay, the less you end up paying back. All payments are equal for PSLF therefore, lower payments are always better for the borrower. The $0/mo qualifying payment has the same PSLF value as a $3,000/mo qualifying payment. Once you rack up 120 qualified payments, all remaining qualifying debt vanishes tax-free. The physician that ends up paying the lowest possible total 120 qualifying payments will maximize PSLF value. In most cases, additional payments to principal are worthless. Seems odd right? If you don’t believe me, check out the rules here.

Student Loan Perks for New Doctors

As 501(c)3 hospitals implement student loan repayment perks, they fail to consider the PSLF benefit. In the earlier example, Dr. Smith also happens to be on track for PSLF. In fact, he signed on with this hospital partly because they were a 501c3 so that he could continue qualifying for the program. He’s already satisfied 60 PSLF qualifying payments during residency and fellowship. Therefore, all he needs is 60 more payments to receive full forgiveness. Dr. Smith isn’t sure how the $75,000 will affect PSLF however he assumes it can’t hurt. As strange as it might seem, the $75,000 paid toward his student loans has no affect on PSLF except that it’s taxable income and therefore increases his total remaining payments by $7,500. It turns out he would have been better off receiving nothing. On top of this, Dr. Smith has to pay tax on the $75,000. IF we assume the tax is 40%, that’s $30,000.

In this case, Dr. Smith would have benefited $37,500 by declining the student loan perk. The hospital would have also saved $75,000. That’s $112,500 of missed opportunity.

PSLF Friendly Student Loan Perks

One solution would be for 501c3 hospitals to stop paying student loan stipends directly to servicers. Instead they could pay the borrower directly. However this would not incentivize physicians to maximize PSLF and it wouldn’t save the hospital any money.

To accomplish the desired outcome, 501(c)3 and government hospitals must restructure their student loan recruitment perks to consider PSLF. Because of it’s surprising complexity, it’s rare to see physicians maximizing the program.

A better solution would be for hospitals to use a small portion of their “student loan perk” funds to hire student loan consultants for their new physicians to help them navigate and maximize PSLF. Hospitals could then reimburse the physician for successful PSLF payments made. This would incentivize physicians to manage PSLF effectively and lower the hospital’s loan reimbursement payments. This would save the hospital money and help physicians eliminate their student loan burden faster.

PSLF has changed the game and hospitals must adapt if they want to attract and retain top physician talent. It’s only a matter of time before hospitals figure this stuff out and start offering new and improved recruitment incentives that help address the student loan problem. In the mean time, if you have a similar offer, it’s worth having a conversation with your employer about an alternative set-up that could ultimately save you thousands.

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© Wrenne Financial Planning | Crafted by Harris & Ward

Wrenne Financial Planning LLC (“WFP”) is a registered investment adviser offering advisory services in the State of KY, TX, TN and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. The presence of this website on the Internet shall not be directly or indirectly interpreted as a solicitation of investment advisory services to persons of another jurisdiction unless otherwise permitted by statute. Follow-up or individualized responses to consumers in a particular state by WFP in the rendering of personalized investment advice for compensation shall not be made without our first complying with jurisdiction requirements or pursuant an applicable state exemption.

All written content on this site is for information purposes only. Opinions expressed herein are solely those of WFP, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.

WFP’s Recommended Reads: December 2016

WFP’s Recommended Reads: December 2016

At the end of each month, we provide a list of finance-related articles to help keep you informed about the hot topics in finance. Here are some of the best articles we read in the month of December.

IRAs, RMDs, and the Crisis of Doctors with Too Much Money In Retirement(White Coat Investor).
Phil Demuth, PhD, explores the very real problem for physicians of having too much income in retirement as well as tax-planning strategies for how to most effectively prepare for it.

Ten News Stories that Offer Financial Lessons(Washington Post)
Everything from Prince’s death to the upcoming fiduciary rule. How ten of 2016’s biggest news stories taught us some very important lessons in finance.

20 Rules of Personal Finance(A Wealth of Common Sense)
A great list of rules to always keep in mind regarding your own personal finances. Everything from understanding the difference between salary and savings, to handling major purchases.

Diversification is No Fun(A Wealth of Common Sense)
The cyclical nature of the financial markets is perhaps their single most reliable aspect. For this reason, a truly diversified portfolio will always perform “worse” than the current cycles’ best performing asset class. It is important not to chase after the big performers, as these cycles will inevitably reverse.

Is Early Retirement Great? For Some, It’s Hard Work To Have Fun(New York Times)
Far too many people are counting down the days until they can retire from their careers. This article addresses the importance of life after retirement, and how it’s perhaps more important to retire to something, not just from something.

Tips for Understanding How Doctors Are Paid(Medical Economics)
Great read for doctors new to their careers, or unfamiliar with how exactly they are compensated. This article dives into the structure of compensation agreements and RVU’s and how to best inform yourself so that you can avoid making any costly mistakes with your next practice.

All Indexes Are Not Created Equal(Irrelevant Investor)
How is it that some indexes outperform others within the same asset class? Despite tracking similar indexes, not all funds maintain the same weighting across sectors. It is important to understand that one year’s performance in similar funds does not provide sufficient evidence as to which is superior. As with any investment, we should evaluate based on long-term performance.

What History Tells Us About Your Investments in 2017(Washington Post)
As we move into 2017, there are many prevailing narratives for what to expect in the coming year. This article provides some historical perspective for what we can expect as we enter the year under a new president, as well as a period of rising interest rates, among others.

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© Wrenne Financial Planning | Crafted by Harris & Ward

Wrenne Financial Planning LLC (“WFP”) is a registered investment adviser offering advisory services in the State of KY, TX, TN and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. The presence of this website on the Internet shall not be directly or indirectly interpreted as a solicitation of investment advisory services to persons of another jurisdiction unless otherwise permitted by statute. Follow-up or individualized responses to consumers in a particular state by WFP in the rendering of personalized investment advice for compensation shall not be made without our first complying with jurisdiction requirements or pursuant an applicable state exemption.

All written content on this site is for information purposes only. Opinions expressed herein are solely those of WFP, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.

13 Mistakes Young Physicians Make With Student Loans

13 Mistakes Young Physicians Make With Student Loans

Student loans have quickly become the most complex financial issue facing young physicians. The average physician in training owes well over six figures. And these aren’t your normal run of the mill loans. Student loans today come with high interest rates and 100’s of options to analyze – all of which end up intertwining into personal and professional planning. The additional complexity paired with massive balances dramatically increases the potential for costly errors.

As financial planners for young physicians, student loan planning has become a big part of our business. I can tell you first hand that we see an alarming volume of errors occurring. Even those people I would consider “on the ball” are missing opportunity to the tune of tens to hundreds of thousands of dollars.

I’ll share 13 of the most costly errors we see young physicians making with student loans. My hope is that you can learn from the mistakes of others instead of making these mistakes yourself.

Forbearance

Student loan forbearance is tempting during residency and fellowship. What’s the harm in delaying payments when finances are tight? It’ll be easy to make up on the back end when the big bucks start to come in. After all, student loans are “good debts”. Many young physicians use logic like this to justify entering into forbearance during training. But they’re failing to figure up the true cost of this decision!

Forbearance sets off a number of negative triggers with opaque costs. Collectively these negative side effects make forbearance a terrible idea for anyone with the means to make payments.

Not Going For PSLF

Let’s look at how this might affect someone with $300,000 of unsubsidized federal student loans at 6% coming out of medical school that’s not going for PSLF. To simplify, we’ll assume Income-Driven payments are $0/mo. (which is reasonable for the person legitimately considering forbearance because they lack discretionary income). Forbearance payments are also $0/mo. Check out how the balance grows over time.

Residency Student Loans

Total balance at the end of 4 years of residency:
Forbearance – $378,743.09
IBR/PAYE – $372,000 ($6,743.09 savings)
RePAYE – $336,000 ($42,743.09 savings)

Medical School Loans During Residency

Total balance at the end of 8 years of residency and fellowship:
Forbearance – $478,154.42
IBR/PAYE – $444,000 ($34,154.42 savings)
RePAYE – $372,000 ($106,154.42 savings)

When PSLF isn’t in play, total balance owed is critical because 100% must be paid back. If you come out of training owing $100,000+ more because of poor decisions, you must own it.

Going For PSLF

Forbearance is also terrible for the PSLF crowd but for totally different reasons. PSLF makes total balance much less important. Instead, it’s all about making qualified monthly payments that are as small as possible (lower payments = greater forgiveness). Let’s use the same loan scenario and consider PSLF.

Say Dr. Davis originally plans to go into private practice and chooses to forbear on loans during residency. Then midway through, she realizes the hospital she’ll likely work for is a PSLF eligible not-for-profit. At this point, she starts the PSLF clock by signing us for RePAYE. But what’s the cost of missing two years? Let’s assume her payments would have been $0/mo. for the first two years of residency. When she is in practice, payments max out at $3,000/mo.

With PSLF, you clock in 120 qualified payments and then you’re done with the loans. As far as PSLF is concerned, $0/mo payments are equal to $3,000/mo payments. She misses the opportunity for 24 “free” PSLF payments and is forced to make them up in practice at a cost of $3,000/mo. In just two years, this mistake costs her $72,000 ($3,000 times 24 months) in future wealth.

In these examples we looked at extended periods of forbearance during training. It’s also common to see intermittent forbearance periods (many of which are a surprise to borrowers). We’ll cover these more in mistake #4.

The only way forbearance makes sense is when you truly have a major financial hardship – obviously it’s more important to feed your family than to make payments on student loans (when you could otherwise forbear). I get that. But if you’re fortunate and have enough to cover life’s necessities, don’t forbear. Get rid of your cable TV or your decked-out cell phone plan so you can make the minimum student loan payments.

Wrong Repayment Plan

With so many options on the table, this is bound to happen. You have PAYE, RePAYE, IBR, new IBR, 10 year standard, graduated, extended graduated… and several others.

When PSLF is off the table, student loans act more like traditional debts. In general, it’s wise to minimize interest and maximize payments. Ideally, you pay off debt with the highest interest rate first.

With PSLF, the goal is to make qualified payments at the lowest amount possible. One of the requirements of a “qualified payment” is being on a certain type of repayment plan. If your repayment plan is not qualified, those payments don’t count toward the 120-payment clock. If you are using a qualified repayment plan, the key is to pay the least amount possible. Each payment has the same net effect no matter the amount. Therefore, it’s absolutely critical to make sure your repayment plan offers the lowest possible payments for your circumstances.

For example, many young physicians can qualify for PSLF under RePAYE or IBR but aren’t eligible for PAYE based on the dates their loans were taken out. Most of these physicians are using IBR because it was the original option. However, in many cases, RePAYE provides a payment that’s 30% lower. This easily results in $10,000’s in additional forgiveness. Many are missing this opportunity.

Failure to Consider Tax Implications

Taxes used to be independent of student loans. Today, though, that’s not the case with “income-driven” repayment, PSLF and income-driven forgiveness.

Student loan decisions can affect taxes. If you’re going for income-driven forgiveness (20 or 25 year), you better be prepared to pay income taxes on the ultimate forgiveness amount.

Tax decisions also can affect student loans. Lower PSLF qualifying payments = greater forgiveness. One simple way to lower your PSLF qualifying payments is to make decisions that lower your Adjusted Gross Income – “AGI”. If you save in pre-tax retirement plans like the 401k, your AGI will be lower and, therefore, income-driven payments will be lower. This can ultimately increase the amount forgiven under PSLF and income-driven forgiveness.

Another example… if you’re married and elect to file taxes separately, IBR and PAYE payments only consider one borrower’s income. If the tax cost of filing separately is less than the increased projected forgiveness caused by lowering payments, this strategy can add value.

Income-driven Application Procrastination

We regularly see NSLDS student loan reports showing periods of forbearance around the time people file for income-driven recertification. Often the borrower has no clue that the forbearance periods exist. They submitted the forms before the deadline and never missed a payment. Often, that’s not enough.

Loan servicers need time (apparently a lot of time) to process the application. If you submit the income-driven application a couple weeks before the deadline, it’s likely they will not finish “processing” until after the deadline. The average student loan report we see has intermittent forbearance periods sprinkled into repayment that the borrower was totally unaware of.

Let’s look at an example – Dr. Smith is going for PSLF and his student loans have a 10 year standard payment of $2,500/mo which he expects to begin paying after a few years in practice. During his 5 year training, he has the opportunity to rack up 60 PSLF qualifying payments that average $200/mo. Although he successfully makes all 60 payments, to his surprise, he only gets credit for 50. The 10 non-PSLF payments were actually periods of forbearance he wasn’t aware of. At a net cost of $2,300 per payment, we’re talking $23,000 of total additional costs.

To counter this, submit the application as soon as you receive the annual letter. Fax in the paper version and follow up weekly until you receive confirmation that it’s complete. This may sound like a hassle, but for the average physician with six figure loans going for PSLF, it’s worth thousands to get right.

Failing to Verify Employment

According to the US Government Accountability Office Student Loan Research Report from August ’15, about 147,000 borrowers had employment and loans certified in anticipation of PSLF, and 4 million current direct loan borrowers may be employed in public service. Essentially, less than 4% of those likely eligible for PSLF are proactively positioning themselves for approval. The problem is that people have a choice: Verify now – or – verify later.

“Employment verification” is not required until you apply for PSLF (after 120 payments). You can either verify when you apply or as you progress through time. It seems most people are opting to verify later. They choose to work for 10 years “unverified” and then go back and verify all 10 years at once. This is all happening while they’re waiting to see if they qualify for $10,000’s and sometimes $100,000’s of forgiveness benefits.

Based on my experience helping people apply (over time) for employment verification, I expect this to be a huge mess for some borrowers opting for the procrastination method. I see the challenges and surprises that pop up going through this process year by year. Mistakes are made, people get confused, the process gets dragged out. I can only imagine what that might look like when you try and verify 10 years all at once.

Paying too much Interest

This is mainly for the non-PSLF folks out there. When you’re not going for PSLF, student loans are more like a typical debt. The higher your interest rate, the more you end up paying back. What’s interesting with student loan interest rates is that they vary considerably. There are loans out there with interest rates in the 2% range and others with rates over 10%.

As a general rule of thumb, if you’re not going for PSLF or any other forgiveness program and your rate is above 5%, you should be considering refinance. The higher your rate, the more emphasis I would put on this. Failure to refinance into a lower rate can easily cost $10,000’s in extra interest payments.

Be extremely cautious when refinancing – especially if you or your spouse (see #10) have any chance of going for PSLF or income-driven forgiveness.

Poor Refinancing Decisions

If you or your spouse are eligible for PSLF, refinance is almost always a really bad idea (see #10). You must maintain qualified federal loans in order to maintain eligibility for PSLF. Some borrowers unknowingly refinance when they are qualified for PSLF. Others aren’t confident in PSLF panning out and refinance. Either way, it’s going to cost you.

And for those who aren’t eligible for PSLF, you have to watch out for bad refinancing deals. Many lenders offer student loan refinancing deals that are not in your best interest. Do your homework and make sure you understand the options. Here is more info on several of the lenders offering student loan refinancing.

Bad Consolidation Decisions

Some borrowers fail to consolidate loans they should have consolidated, and others consolidate loans they should have never touched. Still others wait to consolidate and miss out on valuable cost savings. Either way, consolidation mistakes are very common.

Dr. Turner is finishing up medical school, has lots of Direct federal loans and plans to go for PSLF. When she goes through loan exit counseling, she’s confused by all the options. Ultimately, she decides to go for PAYE and will fill out income-driven paperwork before her grace period is up to get the PSLF clock started. Consolidating her loans never crosses her mind – why consolidate two loans? What she doesn’t realize is consolidating into a Direct Consolidation loan immediately after graduation allows income-driven payments to begin much sooner by side-stepping the grace period. If she were able to get payments started six months earlier, it would have increased her projected forgiveness amount by $12,000. For most recent medical school grads, these early payments are very low or even $0.

Dr. Baker is also going for PSLF. He has some Direct Loans and some older FFEL (or non-direct) loans. FFEL loans were very common federal loans before 2010 and aren’t PSLF qualified unless you consolidate them into a Direct Consolidation loan. Dr. Baker chooses to leave the FFEL loans as is because he doesn’t want to mess up his PSLF progress. When you consolidate, this starts your PSLF 120-payment clock. A big misconception is that when you consolidate, you must wrap all loans into the new consolidation loan. Naturally this would discourage someone like Dr. Baker with Direct loans well on their way to PSLF from consolidating an old FFEL loan. Fortunately, it’s not true. You can leave the current Direct loans as is and consolidate the FFEL loans into a separate Direct Consolidation loan. This allows the otherwise non-PSLF loans to joint the party.

Dr. Jones has a similar loan profile to Dr. Baker – mostly Direct loans with some older FFEL loans – except he’s not as far along with PSLF. He hears somewhere that it’s smart to consolidate FFEL loans so they become PSLF qualified. Like Dr. Baker, he believes consolidation is an all or none deal. After running the numbers, he decides it’s best to reset the PSLF clock on all his loans to allow the FFEL loans to be included on PSLF. So he does the full consolidation. This comes with a major cost – all those PSLF payments made on the already qualified loans are lost when he “resets the clock”. Instead, just like Dr. Baker, he should have consolidated the FFEL loans only.

Either one of the above consolidation mistakes eaisly cost tens of thousands of dollars. Be extremely cautious with consolidating your loans. Make sure you have a good reason for each loan you choose to consolidate. And always keep PSLF qualification in mind before making decisions.

Reactive Income-driven Verification

Young physicians, like many people, tend to make reactive decisions. Income-driven verification is no different. They receive the annual notification that it’s time to re-certify and they knock it out. And that’s about the only time they think about it each year. What people don’t realize is they always have the option to volunteer income verification outside the normal annual timeline.

This can prove extremely valuable when income verification results in lower PSLF qualifying payments. This might occur if your income decreased as a result of changing your filing status, going back into training, or reducing moonlighting. Or maybe you’re expecting a pay increase or bonus before your next recertification date. Why not recertify now at the lower income level. If your income decreases or is about to increase, don’t wait until your next verification. Apply now.

Not Considering Spousal Student Loans

For many physicians in private practice, refinance may seem incredibly obvious. Why hang onto your 7% interest rate student loans when lenders are offering 4%? Especially if PSLF is off the table. But what if your spouse is going for PSLF? Many physicians fail to consider the impact a refinance has on their spouse’s federal loans.

Your spouse’s income-driven payment calculation uses income to set payments. The resulting payment then gets prorated between ALL household FEDERAL student loans. In many cases where loan balances are high, the total payment will not be affected when the total federal loan balance decreases as a result of private refinance. Therefore, the income-driven payment due for the family stays the same after refinance. Effectively, the PSLF spouse’s payment increases substantially to compensate. This comes with massive PSLF costs to the total household that typically dwarf interest saved from a refinance.

It may be a good deal for you, but if your spouse is going for PSLF, refinance can end up costing them 10’s of thousands in the missed PSLF benefit. Before refinancing, consider your spouse’s PSLF impact. In many cases, it’s better to keep both spouse’s student loans with the federal government, and save the additional desired payments into a side account. Then as soon as the PSLF spouse qualifies for forgiveness, the non-PSLF spouse refinances (assuming rates are still favorable) and pays a lump sum using the side account.

Not Fighting Servicer Errors

Loan servicers will inevitably make errors that negatively affect unfortunate borrowers. As student loans become even more complex, this will likely increase. It’s a mistake to assume the loan servicer will always look out for you.

You should be keeping an eye on your progress and make sure your records match the loan servicer and NSLDS records. When you spot errors, they should be addressed immediately.

As you submit paperwork and have interactions with loan servicers, it’s important to document everything. Save copies of all paperwork and correspondence (like annual income driven applications and confirmation letters). Write down notes from all calls you make that include the name of the people you talk with and the date of the call.

Taking Bad Advice

As a result of growth in student loan balances and complexity, companies are popping up everywhere claiming to be student loan experts. Be extremely cautious taking advice from a student loan advisor. Figure out if they Fee-only (100% of revenue comes directly from clients) or not. Many of the student loan companies aren’t fee-only and get compensated from student loan refinance companies to send business. That’s a major conflict of interest that can cloud their advice.

Student loan planning today is very different from traditional debt planning. It’s much more complex and traditional rules of thumb don’t apply. As a result, many financial advisors, accountants and other advisors are unknowingly providing the wrong advice.

Improperly Negotiating Student Loan Stipends

Every year, not-for-profit 501(c)(3) hospitals all over the country hire thousands of young physicians. Many offer student loan stipends and repayment packages for new hires. These hospitals agree to pay annual lump-sum student loan payments for new physician hires. Normally these payments are made directly to the student loan servicers.

On the surface, this seems like a fantastic benefit. However, it’s often an absolute waste of resources when PSLF is in play. With PSLF, the goal is to pay the minimum payment. Lump-sum extra payments end up providing no economic benefit as they end up reducing total forgiveness dollar for dollar. On top of that, it’s typically a taxable benefit. So you pay tax on money you effectively give right back to the government. We have seen cases where people are better off not receiving anything at all. It’s a mistake to let this happen without intervening.

A better route would be to negotiate a salary increase instead of student loan payments. Or have the payments paid directly to you. Most hospitals are happy to make the adjustment once they realize it helps you and doesn’t affect them. However, some hospitals won’t allow this even though it’s an absolute waste of money.

Bringing It All Together

As you can see, student loans have become pretty intense. To help you simplify this concept and wrap your head around the best path to take, we created this student loan flow chart you can see below.

Also, if you’re interested in our student loan advising services, check out this page for more info.

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