How to Take Advantage of Student Loan Forgiveness

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How to Take Advantage of Student Loan Forgiveness

In 2007, Congress created the Public Service Loan Forgiveness (PSLF) program. The program is intended to remove the student loan debt of low-salaried public service employees after 10 years. (There is also a similar program for teachers of low-income students, called Teacher Loan Forgiveness.)

To qualify for PSLF’s public service requirement, public service is defined as “employment with a federal, state, or local government agency” or “a not-for-profit organization that has been designated as tax-exempt…under Section 501(c)(3).”

There is also a list of services which, if your for-profit employer offers, can also qualify your employment as public service. The list is essentially public health, education, or law enforcement, but a complete list is in Federal Student Aid’s documentation on the subject.

Your particular job at the company does not matter, merely that you are a fulltime employee (minimum of 30 hours).

Meeting the employment requirement for loan forgiveness is as simple as submitting an Employment Certification Form to Federal Student Aid. They will likely ask for documentation of your employment along with the form, such as a W2, or may contact your employer to confirm your employment.

If the salary of your last tax return is significantly different from the salary you are likely to make (as will be the case for most recent graduates), then you may be required to submit a pay stub to show justification for your approximate income for that tax year.

To qualify for PSLF’s partial financial hardship requirement, you must qualify for and use an income-driven repayment plan for your student loans. You might think that you can’t qualify for financial hardship, but many well-paid families are eligible.

There are three Income-Driven Repayment Plans available: Income-Based Repayment (IBR), Pay As You Earn, and Income-Contingent Repayment (ICR). If you can, you should strive to qualify for Pay As You Earn because it will have the largest benefit.

Although no disbursement requirements exist for ICR, to qualify for IBR or Pay As You Earn, you must have had no outstanding balance with Federal Student Aid on October 1, 2007 and have received a disbursement of a Direct Loan on or after October 1, 2011.

All of these plans are intended for families experiencing a “partial financial hardship” due to student loan payments. Partial hardship is defined as having to pay more than a specific percentage of your monthly “discretionary income” in monthly student loan payments. That percentage is 10% under Pay As You Earn, 15% under IBR, and 20% under ICR.

Discretionary income is the difference between your adjusted-gross income (AGI) and 150% of the poverty guideline for your family size and state of residence.

In the 48 contiguous states, the 2015 poverty guideline is $11,770 for a single person and $15,930 for a married couple. Thus, discretionary income would be AGI minus $17,655 for single and $23,895 for married (150% of the poverty line).

If your AGI puts you at or below the poverty line, then your AGI minus the poverty line would be $0, and your required payments would be $0. If your required scheduled monthly payment is zero, the months where you “paid” zero will count toward the 120 qualifying payments for PSLF, assuming that you are employed fulltime at a qualifying job.

In the same way, all months of full payments, including $0 payments, count towards the repayment period of your loan.

Standard repayment plans cannot be forgiven though for two reasons. First, they only require 120 payments, making it impossible to make 120 qualifying payments and have money due at the end. Second, you are always required to make the minimum payment, so there is no chance that if you are in good standing there will be any loan left at the end of the 10 years.

That being said, if you are currently using a standard repayment plan while employed fulltime with a public service employer, then your payments to the standard repayment plan count towards your 120 payments. However, you must switch to an Income-Driven Repayment plan in order to qualify for and benefit from any form of loan forgiveness.

Furthermore, as their FAQs say, “although you must have a partial financial hardship to initially qualify for IBR and Pay As You Earn, you may remain in the IBR or Pay As You Earn Plan even if you are later determined to no longer have a partial financial hardship” and “your monthly payments will count toward the required 120 payments for PSLF.”

Even if you don’t work for a PSLF qualifying employer, you can still get your student loan forgiven if you qualify for an Income-Driven Repayment plan and owe money after the repayment period is done. The maximum repayment periods are 25 years for ICR and 20 years for IBR and Pay As You Earn.

This means that if you can, you should apply for an income-driven repayment as soon as possible after graduation to increase your chances of receiving student loan forgiveness years later.

Although the partial hardship sounds limiting, you have more control over your AGI than you might think.

To push this program to its limits, imagine a recent graduate age 22 named Susan who is working fulltime for a large a 501(c)(3) non-profit. She is earning $44,505.00, a high-end starting salary.

According to the repayment plan, her discretionary income would be $26,850 ($44,505.00 – $17,655) or $2,237.50 monthly. If she did nothing else and qualified for Pay As You Earn, her monthly payment would be reduced to $223.75 dollars.

With $25,000 of loans at 6.8%, she previously had a standard monthly payment of $287.70, so this would be a step in the right direction. Paying anything less than full monthly payment means that something could be forgiven in 10 years. Furthermore, even if her loan was never forgiven, as we showed in “How Quickly Should I Pay My Student Loans?,” paying less and investing the difference is the best plan for developing wealth.

With a bit of focus though, she can reduce her monthly payment $0. The trick is by reducing her AGI.

In the AGI formula, traditional IRA, traditional employer-sponsored retirement plan, and Health Savings Account (HSA) contributions are all subtracted from wages.

This means that if Susan funds her traditional IRA to its maximum ($5,500), her employer’s 403(b) to its maximum ($18,000), and her HSA to its maximum ($3,350), her AGI would be $17,655 [$44,505.00 – ($5,500 + $18,000 + $3,350)] or exactly 150% of the single poverty line.

Thus, her discretionary income would be $0 and her required payments would be $0.

Filing the paperwork annually to continue to confirm her qualified employment and $0 qualified payment would mean that after 10 years (120 $0 payments), she would be able to finally submit the paperwork to acquire PSLF loan forgiveness.

To do this paperwork, she merely needs to save her proof of employment with a qualified public service employer and proof of qualified payment for those 10 years. On top of having her student loan completely forgiven without spending a penny, she would have contributed $235,000 to her retirement and $33,500 to her HSA by age 32.

If these amounts were regularly invested and earning 9%, during the ten years her total savings would have grown to $513,928 and she still would have qualified to pay nothing and have her student loan completely forgiven.

For a married couple, there is even more potential. A married couple earning $77,545 collectively can reduce their AGI to $23,895.00 and thus their discretionary income to $0 through their traditional IRA contributions, employer-sponsored retirement plans, and HSA contributions ($11,000; $36,000; and $6,650 in total respectively).

At the end of 10 years earning 9%, a married couple’s investments might grow to $1,027,857 and they could still pay nothing and have all their student loans forgiven.

That PSLF favors public employees and nonprofits is unfair, but if you can qualify for loan forgiveness you should take advantage of the offer.

There is no morality to the use of government regulations. If you can qualify to receive government largess, take the money. There is no hypocrisy in playing by the rules and then voting your representative out of office for having supported the legislation that created them.

Photo used here under Flickr Creative Commons.

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Megan Russell has worked with Marotta Wealth Management since 2005. She loves to find ways to make the complexities of financial planning accessible to everyone. Her most popular post: The Complete Guide to Your Washing Machine

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