All very tough choices, good for you for analyzing this as systematically as possible.
I vote option 1
Option 1: Stay on IBR
• Pay minimum amount
• Save each year for tax liability $9,000/yr. or $750/mo. ----> consider placing this in an investment account, over a 20 year timeline [kind of like a 529 plan, just grow more conservative with investments with about 5-7 years prior to the tax bill coming due]
PROS: 1. Lowish monthly payments ---> Flexibility is so important in life, especially with 5 kids!
2. More cash flow to save for retirement/invest ---> I agree
3. Be able to enjoy life a little more ----> lots of ways to enjoy life without spending more, but to each his own
CONS: 1.Tax Liability at end ---> Yup, unless a jubilee occurs, or laws change on this overtime, maybe 50/50 chance?
2. Stress of debt for 20 more years. Longer stay on the plan, more stuck on plan ---> yes this sucks
3. Rapidly increasing principal = Never really pay it off and likely balance somewhere close to $500K at end. ----> I kind of see this like prison in your case... once you've done your 20 years and paid the Tax man at the end, I think you've fulfilled your obligation
*quick question to the forum -> if AMG considers her 401k or 403b to be her "loan payoff account", and decides to pay off the loan forgiveness tax balance in 20 years, would AMG pay a penalty for that? If not, the tax benefits of maxing out that 401k yearly are pretty high.