To anyone on here with significant student loan debt, the Obama administration rolled out a new student loan repayment plan that I think changes the equation for perhaps a majority of student loan borrowers.
The new payment plan came out today and if you have high student loan debt, you might want to look into enrolling.
Summary of Revised PAYE- Requires no proof of a partial financial hardship--you can enroll almost no matter what.
- Adjusts borrowers’ payments to 10% of their disposable income, which is calculated as the difference between their Adjusted Gross Income and 150% of the poverty line. (I'll get to more on this later)
- Borrowers who sign up for REPAYE and work in a government or nonprofit job for 10 years (and make 120 on-time payments) can have the rest of their loan forgiven.
- REPAYE will also forgive the remaining balance on loans for other workers who only have debt for undergraduate study, after 20 years of payments.
- Those who are using the program to repay graduate debt will have their debts forgiven after they have made 25 years’ worth of payments.
- Loans forgiven under REPAYE, whether it is 20 or 25 years, will continue to be taxed.
- If the borrowers monthly payment under REPAYE is less than the monthly interest, the excess interest will be reduced by 50%. This should help people worried about negative amortization.
- Married persons on REPAYE will have their spouses income count towards their monthly payment, regardless of whether or not the filed their taxes jointly or separately. This is a change from PAYE and IBR where separate filers income is not included.
Thus, to summarize: the new plan increase eligibility for income driven repayment plans, caps payments based on ten percent of AGI (not total income), and subsidizes 50% of unpaid interest (thus dramatically reducing the actual interest rate on your loans).
Using Me as an Example: Utilizing REPAYE to Achieve and Accelerate FIREI previously made what turned out to be a quite controversial post about using income driven repayment plans in the context of FIRE:
http://forum.mrmoneymustache.com/ask-a-mustachian/gaming-repaye-and-the-student-loan-system-($148-000-debt)-to-achieve-fire-at-45/
But because the regs are now official and no longer hypothetical (and there's been some slight tweaks), I thought a new post would be helpful to those with high student loan balances.
My SituationI have approximately $148,000 in federal student loan debt and make $47,500 (cue the snarky crowd). If I enrolled in the traditional 10 year repayment plan, my payments would eat almost 50% of my gross income and not allow me to save at all.
I thus do not plan to pay off this debt via the standard repayment plan 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 am going to put money away in tax-deferred retirement accounts and plan to retire at 45.
More Detailed Analysis of Traditional Repayment vs. The REPAYE ProgramI 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 technically 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 (and I'll be 45 by then). If I chose to pay it off in ten years, that would be about $190,000.
Thus, I am now enrolling in 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 the time value of money) than if I were to pay them off in full.
Two of the pros of REPAYE 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%.
Some NumbersIn 2015, my payment will be calculated as follows:
$47,500 Gross Income - $2,500 student loan interest deduction - $1,300 to HSA - $4,000 to 401k (just recently became eligible) - $1,000 to Traditional IRA = $38,700. Subtract 150% of poverty level for a single guy ($17,665) = $21,035. I now owe 10% of that number over the course of the year: $2,104, divided by 12 and my monthly payment is $175.33.
My loan interest will accrue approximately $10,000 over the year. But I'm paying $2,100 towards it, so make it $7,900. Then government subsidizes the remaining half, so my total loan balance only goes up $3,450 this year. Thus, I will have saved almost $20,000 towards retirement and my loan will only have gone up $3,450.
This shows why REPAYE acts a tremendous hedge.Now let's go to 2017 payments. This upcoming year (2016), I intend to max 401k. That will bring AGI (with deductions) down to $25,700. Payments will then be a whopping
$67.05. That decreases my cost of living and thus means I can begin saving even more (529? Traditional IRA? I'll decide later).
As income increases, my payments won't go up because I will continue to find ways to save and keep my AGI low.
REPAYE will therefore encourage you to have a very high savings rate.Projected Assets at Age 45- My 401k (with employer match): $850,000
- Her 401k (Again, Hard to Predict): $350,000
- Paid Off House: somewhere around $150,000-$175,000 value by then
- Brokerage Account: unknown
TOTAL: $1.3M + brokerage account + HSA + tIRA + 529s
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).
A Note on 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.
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.
Early Retirement Context: Of course, what happens when I retire at 45 and still have 7 years of payments to go? Well, my payments will be close to nothing, making this plan all the better.
ConclusionAs you'll see from the other thread, executing this plan is quite controversial. It's definitely not for everyone. But if you ignore the noise on here and think the math checks out, then go for it. I'll leave this with Fields123's post on the subject:
In summary, I think your plan is a good one and the numbers check out. It is difficult to project your income for the next 25 years and it is very possible that you will end up paying more money back under REPAYE. However, if you do, that means you made A LOT of money over that time period. That is a good outcome. The goal is not to somehow beat the government into paying less, the goal is FIRE and this is a tool to get you there. If you manage to wind up paying more back under the program you will also have millions of dollars saved, that is a WIN. The program is also a tremendous hedge. If you die or become disabled, your loans are extinguished but your savings and retirement accounts are not. If you become unemployed, your student loans go to $0, while your bank accounts remain intact. Literally the worst thing that can happen to you with this plan is that you make too much money... what a nice problem to have.