Student loans early payment or government repayment option balancing act

[capnbike]

Topic Title: Spend down and off student loan or allow for government forgiveness program to kick in and keep savings in index funds?

I'm fairly well balanced in the other financial areas of my life (I at least seem to not be terrible at it, so this ends up being the question at hand).

I'm an early 30s Federal employee, and there's a program that allows for student loan forgiveness for making 10 years of payments while working for a government or non-profit organization. I'm 2 years into that period (with forgiveness being in 2022), on a student loan with 6.125% interest and $97,730 balance. I don't carry credit card debt ever, the car is paid off - this is the only debt I have.

I've done the math multiple times to confirm this, but it appears that it doesn't make sense for me to think of paying off the loan early. The reasoning for this is as follows - assuming that my current monthly payment of $833 ends up rising to $900 and $1000 as my family’s income goes up (I have to be on income based repayment), assuming a rate of return of 7% on the money that I'd throw at the loans early (about $50k this year and at least $10k in addition to the payments I'd keep making in the next three years would pay it off), I'd end up losing out. The reason for the losing out is the returns I'd be missing on that money I invested early, when the balance will be paid off in 2022 anyway.

If I weren’t investing the money I’d pay to it, then it would make total sense to do, but because I am, I’m earning a better rate than from savings from paying off the loan early, even 5 years early.

My estimate is that the total payments for the rest of the loan (until forgiveness) is $96,466. The amount of money I'd have if I let the $50k, and two $10k early payments sit in mutual funds until Oct, 2022 is about $117k (at 7% return). The savings I'd have from not having any more loan payments would start in 2018, about $12k a year for 5 years with $69k saved when including ROI.

Am I correct in believing that the total value of paying off the loans early (other than peace of mind type stuff) is the $69k minus the $117k, for about $48k of negative value in paying these loans off early, since they'll be forgiven eventually?

Thanks

[GetItRight]

Unless you get fired, become disabled and can't work, government changes the laws/policies, make a late payment, bank screws up your payment marking an on time payment as late, employer cuts your hours to part time or furloughs/other disqualifying event, etc... So many ways that plan can go wrong and many are outside your control.

Being nearly a decade out, I would not want to tie myself down like that. I'd rather pay it off as quickly as possible while maintaining some quality of life, and then be free to either keep on doing the same thing (while investing significantly more) or make a change (job, location, etc.) if it made sense. I suppose if you're investing what would be your rapid payoff amounts it could be alright but depending on how it's invested if your plan fails and you need to withdraw that money to pay off the loans the government may insist of stealing a much larger portion than if you just paid regular tax rate on it and the remainder to the loan. Too risky IMO.

[Field123]

I disagree with GetItRight. I think you're doing the right thing. I'm in a similar situation and have reached the same conclusion as you. Unlike the poster above, I actually think IBR is the safer play. If you get fired, you can immediately update your income information and have you're monthly payments reduced to 0. Once you start making payments you're fully vested in the program - which is with the Dept. of Education - so they can't just change the rules and take it away. Basically, the worst case is a change in your employment situation, but then the payments under IBR change accordingly. There is always the chance that you move to private employment within the next 8 years, so that could push out your payments under the program for another 10 years, but that would just be another factor in determining whether to take the job.

[studentdoc2]

I'm not sure I quite follow all of your logic, but are you taking into account that any remaining principle that is forgive is counted as income for tax purposes? I believe that's how it works with most of the government forgiveness programs. For example, say the government forgives $40,000 in loans, and you've been making $36,900 a year (after deductions). For taxes purposes, you now have made $76,900 and have to pay 25% taxes on the $40,000, or $10,000.

I don't know if that will change your calculations at all, but it's worth considering.

Personally, I'd just pay off the student loan if I were able to do so for the peace of mind and future flexibility it would allow (what if you don't want to keep working as a federal employee for 8 more years?), but that's just me :).

[tightfistedmiser]

Student loans forgiven due to working for non profit or government are not taxable.

[Fuzz]

Student loans forgiven due to working for non profit or government are not taxable.

Not sure that you're right about this. I believe that the IRS has not decided this issue. I would certainly research this in depth.

A couple thoughts:

(1) You are assuming a 7 percent return after inflation on your investments for the next 10 years. Historically, the market has come close to this, but you can find lots of 10-year periods over the last century where that hasn't been the case.

(2) You're locking yourself in to your workplace for the next 10 years. If you have the option to leave the federal system for much more money, then you've stuck yourself with much more debt to repay. You should price the option of leaving the system. There is some value in being able to move.

(3) Do you love your job? Psychologically knowing that you're going to be there for the next 8 years and that you're doing it for the windfall of repayment is enfeebling for some people. I knew a couple guys who had committed to public loan forgiveness and they always joked about how they were stuck with their government job.

I'd lean toward planning on paying it off. But I think that the non-monetary benefits of knocking out the debt in 3 years are more important.

[tightfistedmiser]

The taxability of this type of student loan forgiveness has already been decided and isn't taxable.  Student loans forgiven for reasons not related to work, such as the forgiveness after 25 years on the IBR plan, are taxable.

IRC Section 801(f)(1): In the case of an individual, gross income does not include any amount which (but for this subsection) would be includible in gross income by reason of the discharge (in whole or in part) of any student loan if such discharge was pursuant to a provision of such loan under which all or part of the indebtedness of the individual would be discharged if the individual worked for a certain period of time in certain professions for any of a broad class of employers.

[Mazzinator]

We're in a similar boat, and we have decided to pay it off, because my husband wants to retire from the army before the 10years would be up. We are using IBR for 3 years though, for the interest forgiveness.

If your reduced payment under IBR does not cover the interest on your loans, the government will pay that interest on your Subsidized Stafford Loans during your first three years in IBR. After three years, and for all other loan types, the interest will accrue but not compound. That means it will be added to your principal, but interest will continue to accrue only on the original principal amount.

So my questions to you are: (these all change your minimum payment)
Are you married?
Any kids?
What is your AGI?
Do you already max out/contribute to traditonal IRA(s) or traditional TSP(s)???
What portion of the loans are unsubsidized vs Sub?

I'm very interested to see what others say!!!

[mozar]

I didn't understand your math but maybe its because I'm tired, but I agree with the posters who say pay it off early. Also depends on your income and demand in your career. And what is your payment schedule? If you are paying 1000 a month for 10 years that would be 120k. With 6% interest over ten years you will pay 60k more in interest. So in ten years you will have paid 120k out of 160k in loans. Then 40k will be forgiven?

My former co-worker is doing the forgiveness program. She is three years in. She hates her job, but it is very stable. I considered going that path but I decided to pay off my loan. It took me 5 years to pay off 130k. I was working as a government contractor along side with civil servants for the past two years. I recently left for a 10k raise and better benefits, which my former co-worker can't do, so she is missing out on higher lifetime earnings as well.

So to do the math the way I understand it. Pay 97k over 5 years and make 69k over the next 5 years. Or pay 120k and end up with 117k (I'm assuming you are investing that extra thousand you are not using to pay the loan off early) after ten years. First scenario you lose 28k, second scenario you lose 3k. So you come out 25k ahead with goverment forgiveness. Do you think you can get higher raises with public than with corporate? Also income rises fastest in your thirties and then flattens in your forties. For me that 10k raise equals 100k extra over the next ten years which beats 25k with measly raises any day. It all comes down to the risk you are willing to take on.

[studentdoc2]

The taxability of this type of student loan forgiveness has already been decided and isn't taxable.  Student loans forgiven for reasons not related to work, such as the forgiveness after 25 years on the IBR plan, are taxable.

Oops! Okay, my mistaken. Thanks to you guys for correcting me. I didn't realize the difference between this and the taxable forgiveness plans.

My vote still stands to pay it off early, but I fully admit that's more of an emotional/security decision rather than a purely financial one.

[capnbike]

Wow - lot of smart responses quickly.

I'll clarify a few things as I understand them, and try to avoid rehashing items others explained well. - Sorry for the long length

For income based repayment, if I'm suddenly making less money the payments go down, and if I'm making no money, then my payments are $0. Also, for the forgiveness program, the count towards repayment is actually number of months that payments were made under income based repayment plan and while working for any non-profit or government organization. That means I could leave my job and go to a non-profit, or another government agency or even local government, and that count keeps going. I essentially have 97 payments left, and I can pay however I want under those conditions.

So, if I don't like my job I can jump to a lot of other places, particularly since I work in DC and a lot of agency workforces are nearing retirement, meaning I have a lot of choices to jump into in the future.

The challenge with the money I'd throw at the loans too is that it means I'm that much more delayed on my wife and I being able to buy a house. In the DC area we need a large down payment to make the payments reasonable and to get close to 10-20% down. Condos here are around $350k, with houses at $450k+. If you move into shooting gallery type neighborhoods of course you can get lower than that.

I also got into the market with a small inheritance from my family just before the 2008 drop, and so I've gotten to watch things as investments have struggled since then. The funds I invested in did have an over 7% average annual increase since then, even counting the drop. My investments generally side towards the "low expense, lower risk, moderate returns" type. So, over a multi-year time span I'm not too worried about local market fluctuations. Maybe I'm stupid for that, but MMM does seem to go along with that kind of thought.

I'm married, and I am currently maxing out my TSP (401k for non-gov folks) as well as my Roth IRA, no kids yet, the loans are a 50/50 mix of subsidized and unsub, and my current payments ($833) are more than the minimum to cover the interest, so that's not been an issue for a while. Our AGI for the last year was about $97k I think. My salary before taxes is around $95k, which at my younger age will be hard to surpass quickly (from talking with other similarly educated friends).

To recap my estimates - I have payments until October 2022, 8 more years. My estimate is that the total payments for the rest of the loan (until forgiveness) is $96,466 - that includes an estimate of $833 payments until next april, $900 for the year after that, and $1000 for the remaining time (less than 6 years). Those are high estimates of my payments. The amount of money I'd have if I let the $50k, and two $10k early payments sit in mutual funds until Oct, 2022 is about $117k (at a 7% return). The savings I'd have from not having any more loan payments would start in 2018, about $12k a year for 5 years with $69k saved when including a 7% return on investment from putting the money into mutual funds.

[mozar]

I still don't understand your math but I want to address some of your assumptions. It's true that a lot of civil servants are approaching retirement but a lot of work is being automated, consolidated (one person doing two or more jobs), and work is being sent to lower COL cities. Agencies are moving out of DC (see FBI, Census).

Do you want kids? The public schools in DC remain terrible, and the charter schools have long wait lists. At current prices I don't think it's worth it to buy property in DC. And if you have kids you will not want to stay (based on your shooting gallery statement). 

If you make 95k before taxes you could easily pay off your loans in two years. I made 55k before taxes and paid off 130k in five years.

[capnbike]

Automation is happening in some areas, but there are many essential government functions that require people actually working for the government, and most of the multiple jobs being moved into one is being accomplished via a decreased amount of hiring to replace retirees - which got toned down several years ago. The workforce has a good sense of upcoming changes, since we're a group that's sensitive to change. And agencies moving out of the city generally means being within the same metro area - my agency moved from one area to another before I started, and all the same people went from one place to another, and the FBI's plans for moving are all within the same area, it's like moving from central city to north of it.

From living in DC, the schools are dependent very much upon neighborhood, just as the safety does. Where I live the schools are actually quite good and comparable to the very good schools in Bethesda just outside of the district, and I'd feel perfectly safe regardless of time of day in quite a few areas around me. The rents in the DC area are also high, which makes it pretty worthwhile to buy instead of rent if you can get to that position. In general though - I like it here, and don't have a strong urge to leave for some time - this place feels like home for me. The neighborhoods are walkable, have mass transit access, and there's a lot available around here.

In general I guess I don't see a lot of risk in my job or finding other similar opportunities (it's easier to find a job in gov when you work there already), and I don't see a large urge to try to be jumping location in 8 years - since my wife also has the education to get a solid job here, and we can expect our AGI to go up - and two high earners jumping around for jobs becomes a more challenging task to pull off.

[Mazzinator]

I understand your math, maybe because i've crunched them too.

With 8 yrs to go, minimum payments.

Yr 1
$833 x 12 = ~$10k
Yr 2
$900 x 12 = $10,800
Yrs 3-8
$1000 x 72 = $72,000

Total = ~$93k (close to your $96,466) total amount of debt paid

With
Yr 1
$50k invested
Yrs 2 & 3
$10k/yr invested

Total = $70k (+ 7% compounding over 8 yrs)

Total investments = $117k

OR

Yr 1
$10k min payments + $50k = $60k
Yr 2 & 3
$10k/yr min ($20k) + $10k/yr extra ($20k) = $40k

Total = ~$100k (loans paid off)

Yrs 4-8
$12k/yr (which was the min payment, now invested) =$60k (+ compounding of 7% over 5 yrs)

Total investments=~$69k

Hope that helps clarify to others...

Yes, i think your math is correct...theorectically, yes you will "make" $48k MORE by investing your money rather than paying off your debt. The biggest issue is that shit happens, and a lot of shit can happen in 8yrs.

I'd go a step further, to get the most benefit. You want these minimum payments to be as small as possible. The way to do that is to lower your AGI. The easiest way to go all traditional, no more Roth, and to max those out. I understand the years almost over and your wife may not be able to max it out, but she should contribute as much as possible for 2014 and then for the next 8 yrs max them out. Also, even though you've already maxed out your Roth ira for 2014, you can call and have them "recharacherized" for 2014, and max out your wifes traditional IRA for 2014.

Here's some math so you can see what i'm saying. Assumes your agi for 2014, after maxing your tsp, is the same. (I know i don't have all your exact info)

$97k AGI
-$17,500 (wifes 401k)
-$11,000 (traditional IRA x 2)

= $68,500 (new, lower AGI)

Which means new lower minimum payment on IBR = $560/month x 8 yrs = ~$55k (total paid)

https://studentloans.gov/myDirectLoan/mobile/repayment/repaymentEstimator.action#view-repayment-plans

Also, having kids lowers your minimum payment...not saying you should have them, just an fyi...

[drak0017]

Have you looked into whether your federal agency has a Student Loan Repayment Program?  The federal government allows federal agencies to repay up to $60,000 of federal student loans in exchange for an agreement to stay in your job for a certain period of time (no less than 3 years, though).  Agencies can pay a max of $10,000/year and the payments are considered income so taxes are withheld, so you don't quite get the full $10K, but by making my regular payments I made up the difference.

I worked for the federal government for almost 10 years and used the program at my agency (in combination with continuing to make regular payments) to repay my law school loans in less than 10 years.  If you have any remaining amount left when you hit the 10 year mark, then it can be forgiven under the program you reference. 

[Psychstache]

I'd go a step further, to get the most benefit. You want these minimum payments to be as small as possible. The way to do that is to lower your AGI.

This is the most important piece that you need to be mindful of if you want to make sure that the risk of going with PSLF is worth it. In addition to the ones mazz mentioned, you might want to find out if your employer offers a governmental 457. That would be another 17.5k/yr that could be removed from your MAGI, and it is easier money to access in early retirement.

[capnbike]

I'd go a step further, to get the most benefit. You want these minimum payments to be as small as possible. The way to do that is to lower your AGI. The easiest way to go all traditional, no more Roth, and to max those out. I understand the years almost over and your wife may not be able to max it out, but she should contribute as much as possible for 2014 and then for the next 8 yrs max them out. Also, even though you've already maxed out your Roth ira for 2014, you can call and have them "recharacherized" for 2014, and max out your wifes traditional IRA for 2014.

Now that, that is something very interesting to think about, and I greatly appreciate you doing that quick math to show the benefits - I'll need to work up some spreadsheets to look at that option and see what I'd like to do. Looking at it - since our AGI last year was $97k, does that mean I have to pull that number down significantly using my wife's 401k to make sure the MAGI is low enough that the IRS will let us fully deduct? This may be the year we start to do a tax preparer instead of turbotax.

Have you looked into whether your federal agency has a Student Loan Repayment Program? 

I've never heard of my agency actually providing this to people, but I'm double checking with my boss to make sure. She's looking into it now. Essentially I feel like this math is very much a tipping point - on paper for me it makes more sense to do PSLF, but if I have another set of factors I can throw in, that can make it swing stronger to one side or the other. Decreasing AGI (which I already do a bit with maxing out TSP/401k) swings it one way, but if my work agreed to help pay the principle, then almost any assistance over $10k from them I think could swing it back towards early repayment.

In addition to the ones mazz mentioned, you might want to find out if your employer offers a governmental 457. That would be another 17.5k/yr that could be removed from your MAGI, and it is easier money to access in early retirement.

I've never heard of that - another thing I need to research to be informed on this. Are there any pitfalls or anything else that comes to mind for you that I should keep appraised of for this?

[Catbert]

No 457 plans in the Federal government. 

[jka468]

The only assumption of yours that I hate is the 7% annualized ROR over the next 10 years. I'm not nearly as optomistic about the market as that number would suggest, but then again who the hell knows.

[Mazzinator]

[quoteLooking at it - since our AGI last year was $97k, does that mean I have to pull that number down significantly using my wife's 401k to make sure the MAGI is low enough that the IRS will let us fully deduct? This may be the year we start to do a tax preparer instead of turbotax.][/quote]

I'm no tax expert, but i think a "phase out" begins at $96k, not an all or nothing type situation. But you're sooooo close (well, i'm guessing you are)

There are a ton of tax experts on here that could help. I know they've helped me in the past.

[mozar]

A federal agency

[midwifemustache]

My husband and I file our taxes separately to lower his AGI. Our combined income is 200k but he only pays about 380 per month. (160k loans) We lose some tax advantages but overall it is worth it.

[capnbike]

My husband and I file our taxes separately to lower his AGI. Our combined income is 200k but he only pays about 380 per month. (160k loans) We lose some tax advantages but overall it is worth it.

I've thought about filing separately, but I make almost double what my wife does, so I jump up a tax bracket if we do that. It could still make sense to do, but I'd have to do some math to figure that out - I've just seen that it jumps up a bracket filing separately and go "welp, that won't happen I suppose"

[fields]

If you are married and file separately, they will only count your income, not your spouses, in determining your payment amount? Seriously?  That would help me tremendously...

[LipFoliage303]

I want to echo the other folks saying to lower your AGI as much as possible. You want your IBR payments as low as possible these next 8 years. Best of luck to you.

[capnbike]

If you are married and file separately, they will only count your income, not your spouses, in determining your payment amount? Seriously?  That would help me tremendously...

The rates for married filing singly are a bit different than for singles, so keep that in mind

http://www.bankrate.com/finance/taxes/tax-brackets.aspx