Many student loan borrowers are worried about the risks of relying on Public Service Loan Forgiveness (PSLF). In the episode, find out why these risks are vastly overestimated as well as the histories of PSLF repeal attempts and taxable loan forgiveness. Also learn what you need to do in the extremely unlikely case that forgiveness programs are eliminated.
In today’s episode, you’ll find out:
- Why, similar to other government programs, PSLF is unlikely to be repealed
- Other programs like PSLF that haven’t been repealed, despite massive costs
- The history of PSLF repeal attempts
- Why politicians are unlikely to try to have PSLF completely taken away
- What would happen in the unlikely event that PSLF was repealed
- How your savings rate affects how long you’d need to work before retiring
- The two kinds of people worried about PSLF going away
- The history of taxable loan forgiveness
- Government approaches to tax bombs
- Why having a high savings rate means you don’t need to worry about suddenly owing your forgiven loan balance
- How Congress might deal with taxable loan forgiveness in the future
- The history of income-driven repayment plans
- The idea behind the new Pay As You Earn plan that some politicians are trying to pass
- What could happen to you if any of these programs were eliminated
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Episode 30 Transcript
Travis Hornsby [00:00:01]Welcome to another episode of the Student Loan Planner Podcast. This is Travis Hornsby, and today, we are going to talk about PSLF (Public Service Loan Forgiveness) forgiveness in general — like, taxable forgiveness and income-based plans and how risky it really is. And what’s really fascinating to me is whenever I go over to, like, a Facebook group that’s talking about student loans and I see some of the comments people make — golly, people are terrified that the government and Congress is going to take something away.
Travis [00:00:28] If you think about radio shows and different kind of personal finance experts out there, they really popularize the idea that Congress can’t be trusted. The government can’t be trusted. They’re going to pull the rug out from under you. You’re going to be totally screwed, and there’s just absolutely nothing that you’re going to be able to do that will allow you to rely on these forgiveness programs. And I actually think that that’s really hurting people out there. It’s really causing a lot of damage.
Travis [00:00:53] Just today, I had a case where some person was paying an extra, like, $5,000 a year on loans that were set up to be forgiven — and golly, that just makes no sense. You’re basically giving Uncle Sam free money, if forgiveness can actually apply to you and the math supports it. And I’m going to prove it in this episode of our podcast today by going through a couple different talking points that will hopefully convince you that people’s fears about forgiveness and income-based plans are really anxieties that are not based on math; they’re based on pure emotion.
Travis [00:01:24] So we’re going to talk about this issue in three different parts. We’re going to first talk about PSLF — Public Service Loan Forgiveness. So if you’re not interested in that or that doesn’t apply to you, feel free to skip ahead. We’re going to talk about loan forgiveness in general — the one that you do PAYE (Pay As You Earn) or REPAYE (Revised Pay As You Earn) or IBR (Income-Based Repayment), and you have a tax bomb at the end of it. And then also we’re going to talk about income-based plans and the risk that those face. So, could IBR go away? Could REPAYE go away? Could PAYE go away? These kind of questions.
Other programs like PSLF that haven’t been repealed, despite massive costs
Travis [00:01:54] So first off, let’s talk about Public Service Loan Forgiveness. This is a program that people always ask me, like, “Travis, do you think this is going to go away? What chance do you think this has of actually being a thing?” And I’d like to compare PSLF to some other government programs that exist that people have also talked about repealing — for some cases, 10 years; in other cases, 50 to 60 years; and other cases, 70 to 80 years.
Travis [00:02:20] So the first one that you’ll be a lot — very familiar with is the ACA (Affordable Care Act). The Obamacare plan, as it sometimes is called. That got passed when — oh, about, you know, 10 years ago, give or take. Right? That program got passed, and the political discussion has been about nothing but repealing or replacing that, you know, with Republicans. Democrats, in some cases, would like to go further than that.
Travis [00:02:42] But this is a program that everybody feels like, “Oh, it’s not safe.” Even my in-laws that could potentially benefit from some ACA subsidies, they’ve been like, “Oh, we can’t use that. It’s going to go away.” But guess what? It hasn’t gone away.
Travis [00:02:53] And one of my friends actually works for one of these big insurance companies that does ACA and Medicaid plans, and their stock is absolutely booming under a Republican administration. Why is that? Because Wall Street is basically saying that that program is going absolutely nowhere. And so what’s interesting about that is, if you think about the ACA, that’s something that, yeah, sure, it could go away. Right? It could also get more beneficial in terms of the people who benefit from it. It could get more generous if you had, you know, an all-Democrat controlled House, Senate and White House. And it’s unlikely to completely go away. Even the Republicans have proposed to keep the pre-existing condition protection, right?
Travis [00:03:35] So that’s a 10-year-old program that has shown really no signs of going away, even though that’s a very, very hot button issue and something that costs probably in the trillions of dollars long term. And that’s something that they have not been able to successfully replace or repeal.
Travis [00:03:51] Medicare is a program that got started in the 60s, and Medicare had tons of opposition when it came about. This is a program that also has gotten steadily more generous over time. The taxes to fund Medicare are a percentage withdrawal from your pay stubs — basically from your paycheck. And the Medicare tax has gone steadily up, and the payouts to doctors and the stuff that it covers has also expanded over time. Even so, the Medicare program is massively underfunded. We have to make tons of changes to this program to be able to keep it, regardless of what kind of side of the aisle you’re on.
Travis [00:04:26] Now there’s different ways to do that. And you could either have higher taxes. You could put them on everybody or the wealthy. Or alternatively, you could lower payments to providers, like doctors and physicians and other people that take Medicare, and maybe have fewer people accept Medicare. It would be more difficult to get access to care. Or you could do some combination of that.
Travis [00:04:45] But Medicare has been around for 50-, 60-something years, and it has shown no potential to go away. Because we as Americans — when we pass a program, once it gets sort of to the point of critical mass where you have enough people benefiting from it, it’s too politically popular to kill it. That’s just reality.
Travis [00:05:02] Social Security has been around since the 30s, I think, and that is a program that is even older than Medicare and probably even more popular, I would have to guess. And that is something that everybody always scaremongers people into saying that, you know, Social Security’s not going to be around for future generations, and that is patently false.
Travis [00:05:24] The reason is because we had tons of seniors in poverty before Social Security, and AARP (American Association of Retired Persons) exists. And it is a massive lobby for Social Security, and Social Security’s absolutely going nowhere. In fact, what will probably happen is we’ll have some sort of benefit cuts or tax increases — but probably both. And it’s going to stay around and not go away.
Travis [00:05:43] One thing that all three of those programs — ACA, Social Security and Medicare — have in common is that they will cost trillions and trillions and trillions of dollars to cover, and it is the vast majority of where our, basically, our budget deficit and our spending goes. It’s really kind of funny to me when people don’t know, like, the budget — it’s really fascinating. If you look at things like discretionary spending and pork barrel projects and all those other things — interest on debt — it’s actually a minority of the budget. The majority of the budget goes to, you know, social programs like the three that I mentioned. That’s pretty interesting.
Travis [00:06:23] And the word student loans — even though it is very, very expensive, in the grand scheme of things, the forgiveness that the government has promised — and even the projected forgiveness that I think that the government has promised under PSLF — is in the hundreds of billions right now, which sounds like a lot. But that’s over a long period of time. And if you compare that to an underfunded liability on some of these other programs in the tens of trillions, it’s really kind of small potatoes. So, you know, you probably have bigger priorities if you’re Congress than eliminating this one program.
The history of PSLF repeal attempts
Travis [00:06:55] But let’s talk about it anyway. Let’s talk about the history of PSLF repeals. So in 2015, approximately, President Obama submitted a budget, I believe, that had PSLF being capped for the first time at about $57,500. That is an important number because that’s approximately what the undergraduate borrowing limit is for Stafford loans. In other words, President Obama was effectively saying — or at least, his staff was effectively saying, you know, “We don’t think that it is wise to give out PSLF forgiveness to graduate degree holders, and that’s why we want to try to limit it to people who basically come out of undergrad and do a public service job. And they can get their debt forgiven.”.
Travis [00:07:31] And people lost their minds, especially higher-debt borrowers. And they called their Congress people, their senators. All the borrower advocates that exist in Washington, D.C. did the same. And the president dropped that proposal, and that did not make it into any kind of bill.
Travis [00:07:49] And [Senate Majority Leader] Mitch McConnell, who, you know, is running the Senate, has been running Senate for several years now, basically tried to repeal PSLF around that same time, except his proposal would basically just apply for new borrowers only. It wouldn’t be capped. It would just be gone. And that went absolutely nowhere, even though the proposal was only to repeal it for future borrowers instead of existing borrowers. Even the cap on forgiveness — it was very unclear because it wasn’t well-fleshed out, but that probably would have only applied to future borrowers.
Travis [00:08:18] The Prosper Act, in 2017 approximately, the House Republicans tried to put out a proposal for their own version of what they wanted to do for student loans. The House is always more conservative, generally, than the Senate. And when Republicans control the House, their proposals for student loans tend to be more conservative than the Senate would want to pass.
Travis [00:08:40] So the Prosper act was very, very conservative. It put a hard cap on borrowing for degree programs, and it made it a lot less generous to pay student loans under income-based plans. Yet that plan went nowhere because it didn’t have enough support in the Senate, and it did not pass. Yet that super-conservative bill would have grandfathered in people that are going for PSLF currently.
Travis [00:09:04] Now, from the other side of the aisle, the Aim Higher Act was a Democratic proposal around the same time that — It was the House Democrats’ version of student loan reform, and it would drastically expand to PSLF. Which makes sense because, if you think about the big debates in Washington right now, it’s over how much of different goods should society pay for. Like education, health care. You know, should there be a jobs guarantee? Infrastructure, all these things. Like, how much of our lives should government cover, and how much of it should we cover as private citizens, right?
Travis [00:09:34] And so what’s going on with that debate is, if you look at the Democrats’ proposal with the Aim Higher Act, it would include places like Kaiser Permanente — that’s a hospital system in California — and other places that cannot employ physicians directly. They have to employ them through a for-profit group. So those physicians normally would be PSLF eligible, but because of this weird California strange rule about employing physicians not directly, Kaiser Permanente Hospitals are not PSLF eligible. This bill would have focused on trying to fix that. And also broaden the definition, make it a lot easier to get PSLF if you made mistakes in the past by putting more money into the temporary PSLF fund. So that bill was a very generous pro-PSLF bill that made no mention of caps on borrowing.
Travis [00:10:22] So we’ve really had zero mention of any caps on PSLF since President Obama put it in the budget in 2015, which is really interesting. And that’s been the case for either party. Neither party has wanted to cap borrowing forgiveness for PSLF since 2015 at all — just the proposals from Republicans have been to repeal it and Democrats have been to expand it. It’s really been that simple since then.
Travis [00:10:44] In 2019, you’ve had different proposals come out from Sens. [Kirsten] Gillibrand, D-N.Y., and Tim Kaine, D-Va. And then also (Sen.) Elizabeth Warren, D-Mass. And there was this What [You Can] Do For Your Country Act. This was a bill that would also expand PSLF. It would count prior payments made on loans before consolidations. It would have helped with people that had FFEL (Federal Family Education Loan) Loans from before 2010 to make those loans eligible for forgiveness. And you also would have been able to get PSLF 50% after five years. In other words, you could work for five years in a not-for-profit and have half your loans forgiven with their bill.
Travis [00:11:19] So, in other words, Democrats have kind of changed their position of being reserved about PSLF to, basically, unqualified being for it in a big way. So, you know, you could debate why this is. One reason might be Democrats are trying to get incremental progress to get to the point where college is free and covered by the government. Republicans are kind of just very opposed to the idea of doing it at this point — except we’re starting to see some cracks in that, especially in the more-moderate Senate. So we’ll talk about that in a second.
Travis [00:11:51] That’s what’s so fascinating to me, is some of the proposals right now in the Senate — specifically with (Sen.) Lamar Alexander, R-Tenn., Senator Alexander, who controls the Higher Education Committee in the Senate. He is basically proposed to — Well, he hasn’t really even mentioned PSLF really all that much. I mean, I’m presuming that they would want to repeal it, but I think his proposal is just mainly focused on getting something passed where he can have an impact on student policy for the next 10 to 15 years. And it seems like the Senate Republicans have really kind of lost some interest in trying to defeat PSLF after trying to do it so many times. I think that if they had control over everything, they would still try to do it, but it would, again, only be for future borrowers.
Travis [00:12:34] But it’s interesting to me that the median position in Washington has become more and more pro-PSLF over time as more people qualify for it. Right now, there’s a million — over a million people qualifying for PSLF with over $100 billion on track to be forgiven. That’s the current setup. And there’s all kinds of problems with the way the process is being managed right now that won’t affect those people long term. It’s just it’s very complicated. If you want to go back and listen to it, I would go back and listen to, like, I think episode two of our podcast where we talk a little bit about PSLF and what the reasons are for the high rejection rate and why that’s not a big deal, compared to what people think.
Why politicians are unlikely to try to have PSLF completely taken away
Travis [00:13:09] The next thing I want to mention, too, is PSLF borrowers are a huge interest group. This is a lot of people with a lot of education that are very, very good at knowing where to contact their senators and congress people. I get emails from readers sometimes and listeners that are saying stuff like, you know, they contacted all of their different representatives, constituent services offices, and they got some deals set up with them so that they could expedite the process of qualifying. And they tell them how important it is.
Travis [00:13:36] And that makes a lot of sense. A lot of these folks with PSLF are — got mid-five-figure a high-six-figure balances, and you better believe that these people are going to be very dialed in to this particular issue. And if you have a system or — A thing like PSLF doesn’t cost a lot compared to big, big expensive programs, like Medicare or Social Security. You know, if it doesn’t cost a whole lot to make a lot of super-highly-engaged constituents happy as a politician, that’s, like, a rational decision to not mess with that.
What would happen in the unlikely event that PSLF was repealed
Travis [00:14:06] Let me give you an example to prove, though — Even though PSLF is not very risky for it going away, let me show you why it doesn’t really matter that much if it did. And some of you probably listening are like, “Wow, you’re a terrible person, Travis. I hate you. That is something I don’t even want to consider.” And let me explain why you shouldn’t be so worried about it.
Travis [00:14:29] Let’s take a family medicine physician. So somebody that’s making, you know, $200,000 a year. And we’ll say she’s got $300,000 in loans, and she could go for PSLF or not PSLF. Right? And she’s got a three-year residency, which means she’s making $60,000 a year for three years. And then after that, she’s making $200,000. And we’ll assume that she could live on $10,000 per month really well with a comfortable living standard; it’s about $120,000 a year.
Travis [00:14:54] OK. So we’ve got a doctor. Maybe we can say, you know, Dr. Christine or something like that. And she’s got — $120,000 is her financial independence number that she’s trying to hit. And she’s got a $60,000 per year residency and a $200,000 a year income when she finishes training with the $300k in debt. Right? Just to review those stats.
Travis [00:15:18] So at — 15% of our income going to loans and investing. When should — When could she have work be optional? If you do Pay As You Earn (PAYE), in this case, with Public Service Loan Forgiveness, she would hit a level where she could spend $120,000 per year after 35 years. So that’s a pretty long time, right? And that’s a 15% savings rate, so about 10% is going to loans, 5% going to retirement, approximately, is a 15% level going to loans and investing.
Travis [00:15:48] If you say that she works in the private sector, Pay As You Earn would actually still be the cheapest plan. You would just do it in the 20-year version with the tax bomb instead of the 10-year version with PSLF.
Travis [00:16:00] So, in that scenario, how many more years would she have to work until she would be able to retire? The answer is 40. So 35 with Pay As You Earn and PSLF or 40 years until financial independence with Pay As You Earn without PSLF. So that’s five additional years that she would have to work because of not getting the PSLF program.
How your savings rate affects how long you’d need to work before retiring
Travis [00:16:21] What if she saved more money? If this doctor saved 30%, going to loans and investing, then she would have 26 years until financial independence or being able to retire with PAYE and PSLF or 29 without. So, 15% savings rate, five years’ cost if PSLF goes away, of working. Thirty percent savings rate, three years’ cost of PSLF going away. At a 50% savings rate, she would be able to retire in 20 years with PSLF or 21 years without PSLF.
Travis [00:16:55] And just in case you’re curious, refinancing would cause her to work 22 years. So Pay As You Earn with PSLF, basically the PSLF program in this case is worth about one year at a high savings rate and five years with a bad savings rate or a low savings rate. That’s really fascinating because that kind of illustrates a little bit of what I want to show you with this podcast today.
Travis [00:17:19] With people with a low savings rate — which, there are a lot of folks out there with low savings rates. Most people have low savings rates. Low savings rates to me is if you’re putting less than 5% of your income into investments and retirement. Right? Because your loans — You can’t really eat your loans in retirement. Right? The money you’re going on your loans really — doesn’t really count that much towards what you’re putting into investments.
Travis [00:17:42] So, you know, if you — if you think about, like, the typical American, typical American is probably saving about 5% going to retirement and investing. Given that you have the loans, though, that’s why I use that 15% number because that’s what’s being eaten up by loans, investing and retirement, if you’re doing a 15% savings rate.
Travis [00:18:00] So anyhow, let’s pretend a different scenario because you’re probably listening — some of you out there are listening — and those of you that do send an email to Podcast@StudentLoanPlanner.com, you might send something like, “Yeah, great example, Travis. But that’s a friggin’ $200,000-a-year person. That’s not a $60,000 person that’s got $300,000 in debt that would be totally destroyed without PSLF. So I don’t believe you. PSLF is my everything.”
Travis [00:18:27] And in that scenario, let’s run some more numbers. Right? So we’ll pretend we’ve got a $60,000-per-year psychologist, or something like that, working in a, you know, not-for-profit setting, and she’s just convinced that PSLF going away would be the end. And if you look at that 50% savings rate, then if you have PSLF, this psychologist with the low income with $300,000 of debt — in other words, a 5-to-1 debt-to-income ratio — Holy cow, that’s really high, right? Twenty years until she can retire with PSLF and 23 years without. So that would be an additional three years of working if PSLF went away.
Travis [00:19:08] Now, one to five years of driving into the office every day because PSLF went away. That’s pretty intense. I’ll grant that. Right? But the difference between a 15% savings rate and a 30% savings rate is 10 fewer years of you driving into the office, and the difference between a 15% savings rate and a 50% savings rate is about 20 years of you driving into the office. So we’ll come back to that, but clearly, PSLF is not nearly as important as something you can control, which is your savings rate.
The two kinds of people worried about PSLF going away
Travis [00:19:41] So, people that are really worried about PSLF going away: Here is my theory. There are two kinds of people that get super anxious about PSLF. One is somebody who is an incredible saver who’s got $500,000 of assets. You know, knows everything about backdoor Roth IRAs. Would never hire a financial adviser because they probably know more than them. And somebody who is just super type-A about their finances, and they’re worried that it’s going to go away because anything that reduces the amount of net worth that they have is terrifying because they’re super OCD about their finances.
Travis [00:20:15] And there’s a lot of folks out there — I probably am one of these kind of people — and you just kind of get anxious about something that, if you really think about it, you’re saving so much money. You don’t have to worry about it that much because it’s going to be a minor portion of your net worth one day. So that’s one group of people who get super anxious about PSLF going away.
Travis [00:20:32] The other group of people — and I see this a lot on Facebook groups, from kind of my guesses — is, you know, there’s people who save very little. Folks that have the three to 3.5 times their income house, that they talked themselves into a house being an investment when that’s a joke that it’s an investment in some really high-cost parts of the country. It’s a lifestyle decision. Right?
Travis [00:20:55] So, if you spend a lot of money on housing and cars and you don’t save very much and you don’t track what you — what you spend, then if you are — you’ve got a really low savings rate, then, yeah — You know, I just told you earlier that a low savings rate means that PSLF has a bigger impact. So if you’re really worried about PSLF, the natural thing that you need to do is save more money.
The history of taxable loan forgiveness
Travis [00:21:15] Okay, so I’m done ranting about PSLF. Let’s talk about taxable loan forgiveness because that’s applying to a lot of people out there, probably even more people that PSLF applies to. So let’s talk real quickly about the history of people doing income-driven programs that are not going to get their loans forgiven tax-free, and they’re going to do it over 20 or 25 years instead of 10 years like those lucky PSLF rascals out there.
Travis [00:21:39] You know, it’s a podcast, right? You got to entertain yourself. So, sorry if I called you a rascal.
Travis [00:21:45] So ICR (Income-Contingent Repayment) is a program that was around prior to 2007. It’s been around actually, I think, since the 90s — Income Contingent Repayment. The problem is you had to have a Ph.D. in the Department of Education bureaucracy to figure out how to sign up for it. And even if you did sign up for it, it was such a high percentage of your income that very, very few people ever ended up benefiting from it.
Travis [00:22:08] And also, prior to 2007, you had all these folks that were benefiting from, like, 2% interest rates. Right? That people have just decided to keep their loans around for much, much longer. And that is not a reason why you would want to pay a high percentage of your income on a loan that’s, like, a 2% interest rate, right? And that’s, like, the interest rates of the mid-2000s were in the 2% range.
Travis [00:22:29] In 2007, they passed IBR for the first time, which, in other words, they made it easy to sign up for an income-based plan when it was extremely complicated before. And then in 2009 — they didn’t really make IBR available until 2009. And then in 2013, approximately, Pay As You Earn, which is a 20-year plan, became available. So if I’m doing my math right off the top of my head, Income-Based Repayment with no PSLF, you’re going to start seeing people get their loans forgiven on that in 2034. With Pay As You Earn, you’re going to see people getting their loans forgiven as early as 2033, if you’re not going to go for PSLF.
Travis [00:23:06] So what’s interesting is, basically, the 2020s and the very-early 2030s, you’re going to see nothing but a whole bunch of hullabaloo about PSLF, and you’re not going to see any tax bombs. So do not expect any big stories about that happening over, like, especially the early 2020s because all the focus is going to be on this massive amount of money that the government is forgiving for 25% of the American workforce that works in a not-for-profit or government employer full time.
Government approaches to tax bombs
Travis [00:23:34] Congress has proposed bills to get rid of this tax bomb. All the time, a Congress person is presenting some sort of bill that would eliminate the tax bomb and make the loan programs in the private sector, or working part time or not at all even, make that tax bomb go away. That’s a very popular thing to propose. It just generally never goes anywhere.
Travis [00:23:56] And the reason for that is, I think, Congress is 1) not really focused on it. Doesn’t really care that much about it compared to other things that are higher on their priority list. I think Congress does not want to encourage people to take tons of debt knowing that there will be absolutely no consequences for it whatsoever because that would spiral the debt size even more than it already is. So they can acknowledge that that’s what they’re basically doing, is creating a tax bill that’s too large to be paid. Because then the Government Accountability Office and the CBO (Congressional Budget Office) and all these, like, watchdog groups would have to actually account for the true cost of these loan programs in reality, and they would give the public a number that would be really embarrassing.
Travis [00:24:37] So I think that there’s some reasons that they don’t do not want to expose what the true cost of forgiveness is going to be. And if you want to look at some really fun loan trivia, then you can check out this Minnesota state representative Greg Davids’ bill: it’s HF882, if you want to google it. And this is a bill that decided — that basically killed the tax bomb at the state level for Minnesota tax filers. So for people who are having their loans forgiven in the state of Minnesota, Minnesota will not be collecting income taxes on that forgiven balance.
Travis [00:25:16] And I would expect that you would have a lot more bills like that passed nationwide for state income taxes. Michigan passed a bill to eliminate taxation on, you know, forgiving student loan debt from disability and death because of a really embarrassing case of them trying to collect on income taxes on a veteran who had a traumatic brain injury, and they were not able to collect the tax bill, for one, because he had a traumatic brain injury. And also, it was really embarrassing that the state officials were trying to do this when, wow, is that just super incompetent in terms of the way that looks. Right? That somebody is trying to collect an income tax bill from a from a veteran who’s got a serious wound from serving your country in Iraq or Afghanistan. Right?
Travis [00:25:57] So I would expect more and more bills passed that would eliminate the tax bomb at the state level. At the federal level, I do not think that politicians will eventually collect it. I’m scared to tell you that because, you know, I’m really afraid that there’s at least one listener — hopefully it’s not you — that is thinking, “All right. Let’s spend some money because I’m not going to have to pay my tax bomb at all.” And that would be really bad if that happens because there’s a long, long history of politicians trying to eliminate the tax bomb, but it is not so much that I’m prepared to say you shouldn’t plan for it.
Travis [00:26:28] Because there’s been different plans, right? So — so President Trump has toyed around with the idea of doing a 30-year plan, which is worse than what currently exists. But he would have no tax bomb. So that’s one kind of approach. Democrats have talked about doing Pay As You Earn for everybody, which is a 20-year plan but also eliminating the tax bomb as well. So the reality might be somewhere in between those two options.
Travis [00:26:52] Or the IRS will just apply the insolvency rule and tax the people that have the money. And people who don’t have the money, where your assets are less than your liabilities, there’s this insolvency rule that’s primarily applied in the case of, you know, weird forgiven debts, like credit card or business debt or something like that. And basically, if you owe more in liabilities than you have in assets, they just don’t even tax the debt because they figure there’s no point in kicking, you know, somebody when they’re down.
Travis [00:27:17] So the really probably the worst-case scenario in terms of what will happen at the end of the 20 or 25 years or even 30 years is you will pay income taxes on the forgiven balance. I cannot imagine any scenario whatsoever where they will just tell you, “Well, yeah. You have $500,000, and we’re just going to tell you [that] you owe the whole thing” I mean, golly, there is just no scenario where that’s even possible. I think if they did that, then in reality, every system that’s ever been proposed has allowed you to consolidate into whatever the new loan program is every 10 years or so. So you could just consolidate it into the new program and just keep rolling the debt and not even worry about making that balloon payment.
Why having a high savings rate means you don’t need to worry about suddenly owing your forgiven loan balance
Travis [00:27:58] So I think that people who are worried about themselves owing that big forgiven balance all at once instead of just paying a tax bomb on it are being very irrational, for one. And two, again, I showed you earlier how important savings rate is. The same numbers apply for people considering refinancing versus forgiveness with that 20- or 25-year tax bomb option. So refinancing versus going for the tax bomb, you know, at a low savings rate, it’s probably worth about five years. At a high savings rate, it’s worth three years. A super-high savings rate is worth one year, on average.
Travis [00:28:33] So that means that, if you did have to pay that full balance all at once because of some just crazy, crazy thing, then if you have a high savings rate, you’ll be able to write the check. And you won’t have any excuses because you will have had a high savings rate. You’ll have a lot of assets.
Travis [00:28:49] So if you’re worried about that — Generally, I get those kind of questions from folks that haven’t realized how important savings rates really are. So that would — That should be your plan, is that you should be able to easily write a check for your full loan balance from your brokerage account in 20 or 25 years if you had to. And that just means that instead of saving whatever you’re saving for your tax bomb, multiply it by, like, two or three, and then you’d be able to cover the full loan balance right out of your brokerage account if you absolutely had to.
How Congress might deal with taxable loan forgiveness in the future
Travis [00:29:16] You know, if you think about taxable loan forgiveness, Congress just has so many more things that are more pressing right now. Everything from questions around the Trump Administration to different national security concerns, trade, immigration, the 2020 election — there’s just a lot of other things that people care about more.
Travis [00:29:32] And whenever people do talk about loan forgiveness, they tend to just talk about some, you know, on the Democratic side, some sort of, you know, very aspirational proposal that would never pass a Republican Senate in a hundred years. Or they’ll talk about some sort of kind of vague proposal how they’re going to help with the debt problems or something. Like, you don’t really see a lot of fleshed-out proposals.
Travis [00:29:53] If you did have a Democratic sweep at some point, I would expect things to get a lot more generous when it comes to taxable loan forgiveness. If you had a Republican sweep, then I just think that they would clamp down on those programs and try to limit it for the future because they’re not interested in screwing over their constituents because a lot of high-income people vote. And the ones that have higher incomes in some cases are Republican voters, if you think about it. Right? So you really wouldn’t want to mess with the constituents that — they’re your highest likelihood voters.
The history of income-driven repayment plans
Travis [00:30:22] In terms of income-driven plans — this is the part three. This is the last part of the podcast, talking about this one. So, income-driven plans have only gotten more and more generous over time with basically one exception. You’ve had ICR as 20% of your income with a deduction that’s 100% of the federal poverty line. Income-Based Repayment is 15 percent of your income with a deduction of 150% of the poverty line. So IBR increased the deduction that you don’t have to pay loans on — or you don’t have to pay payments on — on your income. It also reduced the percentage that they multiply to calculate what your payment is. So that was more generous.
Travis [00:30:57] Pay As You Earn has kept that 150% poverty line deduction but went down from 15% to 10% of your income. And you could file taxes separately, exclude your spouse’s income, that kind of thing, just like IBR. Then Revised Pay As You Earn, you could argue, you got a little less generous, but it gave you a new option because Revised Pay As You Earn gives interest subsidies, if your income is low relative to your debt. And low meaning anything with a debt-to-income ratio over 1.5-to-1, in general. Or 2-to-1, approximately around that level.
Travis [00:31:28] So maybe you could say with the exception of REPAYE, these programs have gotten more and more generous. REPAYE became a 25-year plan instead of a 20-year plan. So a little bit less generous. And it forces you to include your spouse in the repayment calculation. But REPAYE also gave interest subsidies where Pay As You Earn did not give interest subsidies. So if they were going to make these loan forgiveness programs less generous, they would have not done an interest subsidy, but they did. So all they did was create yet another option that people could utilize to cut the cost of their student loans.
Travis [00:31:59] If you kind of think about it, that makes sense a little bit because IBR was a bipartisan idea. That’s basically income-share agreements. Like, think about, like, Mitch Daniels at Purdue wanting to give the option to private investors to be able to offer programs where you could pay based on a percentage of your income instead of some sort of debt-based lending program. And you see this with some, like, coding bootcamp schools where they’ll take a percentage of your earnings instead of actually charge you a bill. Right?
Travis [00:32:29] So IBR — bipartisan idea. President Bush. Democratic Congress. And then President Obama had that very Democratic Congress in 2010, 2009 kind of era during the financial crisis. And that Congress passed a more generous version of IBR, and it was not ready to be implemented quite yet by the 2020 — 2012 election.
Travis [00:32:54] So how did Pay As You Earn come about? President Obama was obviously looking for political advantages to win the election, like any politician would, and found this loophole with Pay As You Earn where they could speed up this implementation of this cheaper loan repayment program. But they couldn’t have it applied to everybody because the congressional action would take more time to develop. So that’s why they passed Pay As You Earn.
Travis [00:33:18] And President Obama gave that speech in front of, I think it was the University of Iowa graduating class of 2012, during a campaign event in Iowa, and they structured it so that the Pay As You Earn program would — The first group of people that could use it would be people that started school and didn’t take out any loans prior to, like, 200. So that basically would be the class of 2012. Right?
Travis [00:33:40] So, you know, if you think about it, it just makes sense. Like, you know, a president giving a speech wants to make a more-generous repayment program that’s on its way already, but they want to speed it up so they can have it get started before the 2012 election. And that graduating class needs to all qualify so they all clap. You know. I kind of view politics as just very pragmatic in terms of the way I look at it. Right? So that’s why Pay As You Earn happened.
Travis [00:34:03] And then REPAYE, which is kind of what Congress intended to eventually happen where it would apply to a lot more people, that got pushed through eventually over the more conservative Congress that took over after that first, you know, very progressive Congress that was around. So President Obama passed that, I believe, with an executive order, and that applied to more people. And they had a few tweaks around the edges probably to — I don’t know exactly why. I probably shouldn’t speculate on that regard. But maybe it was just to avoid, you know, Republicans trying to oppose what President Obama did more aggressively with passing REPAYE.
Travis [00:34:39] So anyhow, you had ICR: super not easy to use. Not very generous at all. IBR: bipartisan, more generous, a lot easier to access. And then more of a Democratic push to have even cheaper repayment programs that were more generous. But then that dialed back a little bit with REPAYE because I think that there were some concerns that high-income earners were excluding, you know, some spousal income from the payment.
Travis [00:35:05] And in general, you know, you see tax penalties for all high-income earners that are married to one another. If you want to avoid paying too much in taxes, don’t get married if you both make over $200,000. Congress doesn’t want you to be married. If you look at the tax rates for, you know, a couple making over $200,000 each, the tax rates in general cause you to pay more taxes than if you were single. So, kind of in line with that sort of viewpoint, that’s, I think, why REPAYE prevented people from excluding their spouse’s income. So I think that that was just trying to bring the REPAYE program more in line with what the tax code does.
The idea behind the possible new Pay As You Earn plan
Travis [00:35:39] So there’s a new option that they’re trying to pass. It’s the — I would call it kind of like the new Pay As You Earn. This is sort of a Republican idea, for the most part, that they would withdraw it from pay stubs. And it would be a 20-year program, and the loans would be forgiven. Probably, you could toss old loans into this.
Travis [00:35:56] This is not a thing right now. You don’t have to worry about this for now. But if it did become a thing, imagine a scenario where a dentist becomes a practice owner and can pay 10% of their income withdrawn from their pay stub. But most dentists and dental specialists set a pay stub to whatever they want it to be, based on their taxes. Right?
Travis [00:36:16] So their CPA (Certified Public Accountant) will say, “We’ll just set it at $100,000. So we pay a lot less in Social Security and Medicare taxes. And then we can do profit distributions on schedule Ks that are actually not subject to payroll taxes.” So you’re able to get around a lot of those hefty 15%, 3% FICA taxes. I mean, 12%, I think Social Security and 3% for Medicare, approximately, I think is the approximate numbers. So if you put more of your income in profit distributions, then that that will give you more access to not having to pay as much in taxes.
Travis [00:36:52] And so if you were able to do Pay As You Earn but directly from your pay stubs, golly, that would be a bonanza for people avoiding, you know, payments on their student loans. That could happen, and it would also exclude spousal income as well. So that would be a program that’s proposed by Republicans, and it’s even more generous than REPAYE or PAYE. And I don’t know if it’ll pass. Maybe some of the more conservative Republicans who realize it would be a bonanza, they’ll resist that, but it could happen. So, you know, if you — if you think about it, that would eliminate the tax penalties for married filing separately where that wouldn’t even be a thing anymore.
What could happen if any of these programs were eliminated
Travis [00:37:26] So what could happen to you if you have loan forgiveness, PSLF or Income-Based Repayment eliminated? If you are a bad saver, a whole lot of bad things could happen to you. You could drive into work for a whole five extra years for no freaking reason other than you borrowed a lot of money, and you don’t have a great plan for paying it back. Right? Or you lose access to the plan that you did have for paying it back.
Travis [00:37:48] So what if you save 15% versus 30% savings rates? Going from 15% to 30% savings rates can take off 10 years off of your working career. Guess how many people — So, 30% savings rate, by the way, is, like, 10% going to loans and 20% going to investing.
Travis [00:38:05] So we did a survey, and we asked our readers and listeners for the Student Loan Planner community, you know, how many of you save more than 20% going to, like, savings and investments? Fewer than 10% of people said that they did that. So fewer than one in 10 people have more than 20% going to investments. So you got 90% of our community, which is really smart, really engaged, really focused on their finances, right? Fewer than one in 10 people had this high savings rate, which is going to save them — and I would say medium high savings rate, like 30% is definitely something that you can hit. So fewer than 10%, fewer than one in 10 people are hitting that end.
Travis [00:38:45] What’s fascinating to me is you see so many people on social media that are so apoplectic about the idea of loan forgiveness going away, you know, especially in places like, you know, the — There’s, like, PSLF Facebook groups and different places like that that I, like, read and have great information. But people are so terrified about these loan forgiveness programs going away. And at that low savings rate, yeah, they maybe have a point. But at a high savings rate, why would you get worried about something that, at most, would cost you six months to a year longer in you’re working career? Right?
Travis [00:39:13] You only would know that if you understood how the math worked. But what’s interesting to me is so many people are worried about something they cannot control. That, if they have a high savings rate, has a very modest impact versus being worried about something that you absolutely can control, like savings rate that you can figure out yourself just by focusing on tracking your spending. Making sure money is going into brokerage accounts, retirement accounts and getting a handle on your student loan debt.
Travis [00:39:38] So fix your mindset where your focus is on what you can control, and then you really won’t have to worry that much about whether or not PSLF or loan forgiveness or income-based repayment is here or if it goes away.
Travis [00:39:48] So that will be my recommendation this week, is to focus on what you can control. Focus on your savings rate and stop worrying about the risk of forgiveness and PSLF and income-based repayment going away because that risk is vastly overestimated.