See Post #168 (page 4) for update as of 07/19/2018, or about three years into REPAYE program.TL;DR (Only Read "The Numbers" if You Know How REPAYE Works)$148,000 in federal student loan debt. My payments are eating almost 50% of my gross income and not allowing me to save at all.
I thus do not plan to pay off this debt and instead plan to enroll in REPAYE. This plan caps payments at 10% of AGI - discretionary income. Two key points: (1) payment is based on AGI, which means I could stuff money into tax-deferred retirement accounts to lower payments and increase my savings rate; and (2) under REPAYE, the government subsidizes 50% of unpaid interest, thus lowering my effective interest rate from 6.7% to 3.3%.
I thus do not plan to ever pay my loans back. I am going to put money away in tax-deferred retirement accounts and plan to retire at 45.
Is this a good plan, or do I have rose-colored glasses on?
BackgroundI graduated law school with $148,000 in student loan debt (all federal) and obtained a job earning just $47,500 per year.
I initially planned to work as hard as possible to pay off these loans, but I'm quickly starting to realize that I'm not going to even begin to be able to save for retirement for 8-9 years until after I'm done with aggressive debt repayment.
However, recent posts have shown me that there might be a better way to achieve financial independence/early retirement. And that involves strategically using Obama's new REPAYE program to lower my student loan payments, increase my savings rate, and retire early.
Traditional Repayment vs. The REPAYE ProgramAgain, I only make $47,500 per year as a lawyer and have $148,000 in student loans averaged at 6.743% interest. I have cut my expenses as much as possible and am able to make $1,200 monthly payments towards my loans. At that rate, it would take about 17 years and 7 months and $309,000 to pay off my loans.
Furthermore, paying off debt feels like throwing money into a black hole, has limited my financial flexibility, made things feel very tight, and made me feel like financial independence is a long, long way away.
Because of the above, I am now strongly considering using the REPAYE (the new PAYE) to pay back my loans. This will allow me to significantly reduce my student loan payments, provide more financial flexibility, begin saving for early retirement, and almost certainly pay less towards my loans (especially considering TVM) than if I were to pay them off in full.
How the REPAYE Program WorksThe Obama administration recently created a new repayment option that will take place at the end of 2015 (October expected).
Pros of REPAYE- No "partial financial hardship" required--you may always stay enrolled;
- Monthly payments are based on the following formula: AGI - 150% of poverty level, which equals your discretionary income; you then pay 10% of your monthly income;
- If your payment does not cover interest charges, the government will subsidize 50% of your accruing interest;
- All federal loan borrowers are eligible; and
- Unpaid balance is forgiven (and subject to tax) after 20 years for undergraduate students and 25 years for graduate students.
Cons of REPAYE- Graduate students must stay in program five extra years;
- If you are married, spousal income counts towards your payment calculation whether you file jointly or separately; and
- There is no cap on monthly payment amount (i.e., it's 10% of your discretionary income, which could be more than the standard 10 year repayment amount).
In summary, I would make these minimum payments for 25 years, the remaining balance would be forgiven, then I would pay the tax liability on the forgiven debt.
Two of the pros are enormously huge in the early retirement context. First, your payment is based on adjusted gross income. That means you can stuff money in tax-deferred retirement accounts to minimize AGI and thus minimize student loan payments.
Second, if your payment does not cover interest, then the government subsidizes 50% of the accruing interest. That effectively lowers my interest rate from 6.7% to 3.3%.
The PlanMy plan is to lower my AGI as much as possible to decrease my student loan payments as much as possible, which would allow me to free up more money to invest and dramatically increase my savings rate.
Right now, for example, my gross income is $47,500. I can get that number significantly down quite easily this year by using the following investment vehicles:
- 401k contributions;
- Traditional IRA contributions;
- HSA contributions;
- Student loan interest deduction; and
- Eventually 529 plans.
Thus, I am now going to contribute $500 per month to my 401k, save the rest, and then shove in the max to my Traditional IRA at the end of the year (gives me a savings rate of about 18% for this entire year which isn't bad considering I was sending $1,200 or more towards debts for six months). Those measures, plus the student loan interest deduction ($2,500 per year), will reduce my AGI to $36,500.
That means my student loan payments next year will be $157 per month. All of those payments will apply to my student loan interest deduction (thus reducing my AGI next year), and the unpaid accruing interest will be subsidized at 50% by the government. My loan balance will thus not grow too significantly despite making such minimum payments.
Because my student loan payment will be lower, I can then reduce my AGI even more in later years, allowing me to save more and decrease payments, and the cycle continues.
The NumbersTraditional Repayment vs. REPAYE- Traditional: the quickest I could pay this off would be 8 years or so, which means $180,000 paid towards loans
- REPAYE Worst Case Scenario: $200,000 paid towards loans plus tax liability. But this is over 25 years, which I think is favorable to putting almost all of my money towards loans for 7-8 years
Assets at Age 45- My Traditional IRA (Assuming 7% returns, maxed from age 27 to 45): $202,000
- GF's Traditional IRA (Assuming 7% returns, maxed from age 27 to 45): $202,000
- My 401k (Hard to Predict, but Goal is $10k/year in contributions until I get raises and can max): $650,000
- Her 401k (Again, Hard to Predict): $250,000
- Paid Off House: somewhere between $150,000-$225,000
- Brokerage Account: unknown
TOTAL: $1.3M + brokerage account
With a paid off house, we then expect to be able to live frugally off less than $60,000 per year (the 4% withdrawal rate).
Long Term Concerns A Growing Balance: Again, even while I'm investing early on, the balance should not grow too significantly. The government is subsidizing 50% of unpaid interest, meaning that my loan (after applying payments) should only accrue about $4,000 per year while far more goes into retirement accounts. If I start making substantial enough income that REPAYE isn't worth it, then the loan won't have grown too much and I can just take care of the loan.
Joint Income: My girlfriend makes decent money ($67,500 gross per year) and we plan to get married in the near future, and she is on board with the plan. Thus, even combining our income, we can do all sorts of things to greatly reduce our combined AGI (i.e., save aggressively) and keep payments low.
Tax Liability: My biggest concern is the tax liability. If I wasn't clear on this before, after 25 years, your loans are forgiven. But if your assets exceed the forgiven debt (which would happen since I was stuffing money into accounts to lower my AGI), then the forgiven debt is taxed at year 25.
I calculate that--at worst--my forgiven debt would be around $250,000. I would do everything in my power to make sure that is taxed at the 28% rate (tax brackets are likely going to move due to inflation), meaning I would owe $70,000. But given the time value of money and the legislative pressure I expect to come towards Congress, I can't pass up this opportunity for something 25 years down the line. Nevertheless, I will come up with a way to pay the tax if it comes due.
High Income: As a young lawyer, I do expect to make more money eventually, whether that means becoming partner at my current firm or moving to a bigger firm in a nearby bigger market. But even if I started making $150,000 per year, I could either pay off the loan or get my AGI down to below $100,000 per year and my payments would be in the $650-$700 range and, more importantly, significantly increase my savings rate.
Your Thoughts?So, with all of that said, I'd love to hear your thoughts about my plan.