Student Loan Forgiveness Plans & Pitfalls
One of the most glorious days in your student loan repayment journey may be the day those loans are forgiven. To make sure that day is a happy one, here’s a brief explanation of the federal loan forgiveness plans out there and pitfalls to avoid.
Types of Forgiveness Plans
All forgiveness plans we’ll be discussing apply only to federal student loans. If you’re not sure whether you have federal loans, check out my post What’s Your Student Loan Type for tips on figuring it out.
There are three types of forgiveness plans out there for federal loans:
Income Driven Repayment Plans
Public Service Loan Forgiveness
Teacher Forgiveness (this only allows for $17,500 and rarely applies to lawyers so I’m not going to go into detail here. For more information on the Teacher Loan Forgiveness Program visit studentaid.gov)
Forgiveness Under Income Driven Repayment Plans
Income-driven repayment (IDR) plans are a real benefit to those graduates who find it difficult to make their monthly payments under the typical 10-year standard repayment plan. For lawyers graduating with an average of $145,000 in student loans (and many graduating with much, much more) the 10-year standard repayment monthly obligations are prohibitively expensive, even for those in Biglaw. So to ease this burden, the federal government created payment plans that would set the monthly payment amount based on a person’s income.
These plans go by many names (PAYE, REPAYE, and IBR to name a few) but have similar characteristics when it comes to how they qualify borrowers for forgiveness. Here’s the basic framework:
Borrower decides they cannot afford the monthly payment under the 10-year standard repayment plan
Borrower applies for Income-Driven Repayment at studentaid.gov (the application must be completed in one sitting)
Borrower now has monthly payments that are much easier to handle with their current income
Borrower re-certifies their income (and any changes) at studentaid.gov each year to get their new monthly payment amount
If the monthly IDR payment is insufficient to cover the monthly interest on the student loan(s) then that interest may be covered, in whole or in part, by the federal government or it may accrue on top of the principal balance — when this happens, borrowers may see their monthly balance actually increase
Depending on the specific IDR plan and the type of loans at issue, the entire balance of the loans is forgiven after 20 or 25 years of IDR payments
The forgiven balance is treated as earned income for that year and is subject to income taxes at the borrower’s current income tax rate
Simple enough, right? IDR plans make affording your monthly student loan payments a reality, especially for lawyers who graduate with hundreds of thousands of dollars of student loan debt. However, such affordable monthly payments do little to eat away at the total balance and often leave borrowers in the uncomfortable position of watching their principal balance increase year over year. That being said, if you actually make it to the 20 or 25-year mark, then that huge balance will be forgiven — so what’s the catch?
In a word, taxes.
Any amounts forgiven under these IDR plans is treated as taxable income in the year it is forgiven. So if you have a balance of $200,000 in student loans, and your marginal tax rate is 24% (as it is for many lawyers), you’ll owe an extra $48,000 in taxes that year. No one likes a $48,000 surprise, so the solution is to not treat it like one. Plan for it.
If you have 20-25 years to get ready for the tax bomb, let’s use that time wisely. My clients start preparing for eventual forgiveness from the moment we figure out it’s the right plan for them. Paying a $48,000 bill seems daunting when you’re not prepared, but if you’ve been slowly putting money away for this day, then it’s not nearly as overwhelming. If you had 20 years to prepare for such a bill, it would only require $200 per month in a savings account earning no interest. That’s generally something we can fit into a spending plan to make sure you get the lower monthly payments you need now, and are prepared for the tax liability in the future.*
There are many calculators out there that will tell you based on your income, what your total monthly payments will be over the entirety of your IDR plan participation and the expected balance that will be forgiven. So using this information, you can calculate the total cost to you of pursuing forgiveness under an IDR plan — (total in monthly payments over the 20-25 years) + (future tax liability) = overall cost of IDR. You can then compare this amount to how much you would pay in total monthly payments were you to pursue Repayment ASAP or Repay Your Way (see more about these options in my post Strategies for paying off student loans).
****The Income Driven Repayment plan waiver that was announced in April 2022 (see factsheet HERE) will now be counting up to 36 months of forbearance payments, $0 payment months, and payments made under non-IDR payment plans toward the IDR forgiveness timeline. Check out this blog post from Student Loan Planner to see if this affects how long you still have until your loans are forgiven before deciding on a repayment strategy.
Another pitfall, stress.
I hear from many lawyers about how hard it is to watch their student loan balance increase every month. Although the promise of eventual forgiveness is out there, it’s very stressful to have such enormous debt hanging over your head for two decades (or more!). So it’s always important to check in with your own feelings about debt, and student loan debt in particular, before deciding whether to pursue the IDR forgiveness option. It may look great on paper, but you have to live with that decision for the next 20-25 years, so you need to feel good about it.
Public Service Loan Forgiveness
It would take more than a blog post to fully explain exactly how the Public Service Loan Forgiveness (PSLF) program works, so let’s just focus on the big picture and pitfalls folks fall into when completing their journey.
The PSLF program was designed to attract graduates to public interest fields by offering forgiveness of their federal student loan debt — with no tax liability. So PSLF is basically the ultimate debt forgiveness program, if you can qualify…
Here’s the basic framework:
Borrower has the type of federal student loans that qualify for PSLF (not all of them do)
Borrower works for an eligible employer (find more info at studentaid.gov)
Borrower makes payments pursuant to an eligible repayment plan (10-year standard or IDR plan)
Borrower certifies employer eligibility annually and confirms all eligible payments are recorded accurately
Borrower makes 120 qualifying payments in the PSLF program
Borrower requests forgiveness and gets a letter in the mail that shows their federal student loans have been discharged!
Easy, right?
So why all the complaints about the PSLF program being broken and borrowers not being able to qualify for the forgiveness they were promised?
Here are the biggest pitfalls for participants in the PSLF program:
Borrower didn’t have the right kind of federal loan — only certain types of federal loans qualify
Borrower wasn’t in the right payment plan — extended and graduated payment plans were very popular when PSLF started so many borrowers thought they were making qualifying payments when they actually weren’t
Borrower did not work for an eligible employer — but they didn’t find this out until they finally did their employer certification and it was denied. One surefire way to avoid this situation is to certify annually
Borrower consolidated after making qualifying payments — consolidating PSLF-eligible loans restarts the clock on PSLF payments. So if you have some individual loans that you’ve been making PSLF payments on for months (or years), be very careful before consolidating. Consolidation creates a brand new loan, one that doesn’t have a history of PSLF payments, so you lose all that credit
All these issues aside, I can tell you from the anecdotal evidence of other lawyers that the PSLF program does work when executed correctly. So keep those records, keep checking up on the government’s records, and you could have all those federal loans forgiven after your 120 payments. You just need to be willing to work at the right job(s) for 10 years to do it.
***The PSLF program has a LIMITED WAIVER OPPORTUNITY available for folks who may not have had the "right" loans, been in the "right" payment plan, or paid the right "amount" to count toward their 120 eligible payments. Check out the details and whether this waiver could help YOU at studentaid.gov.***
So what’s your plan?
Does your career trajectory and lifestyle match up well with a forgiveness plan strategy? If you have primarily federal student loans, it very well may. But there’s an emotional component that shouldn’t be overlooked. So run your numbers, check in with your gut, and figure out if one of these strategies may be a good option for you.
And if you’d like help thinking through how these strategies fit into your overall financial picture, schedule a 20-minute consult with me to start the discussion.
*Jessica Medina, LLC does not give investment, insurance, or tax planning advice and nothing should be construed as such. To the extent you need investment, insurance, or tax planning advice for your specific situation, please seek a professional licensed in those areas.
