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IBR is a trap

Discussion in 'Financial Aid' started by Margo, Sep 10, 2014.

  1. SigmaFS

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    Last response for the evening.
    • At 3% annual return with $1300/month invested = $427k after 20 yrs
    • At 4% annual return with $1150/month invested = $422k
    • At 5% annual return with $1050/month invested = $431k
     
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  3. LaughingMan

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    Just wanted to say thanks all for the good discussion. Good mental break from Anatomy.

    It will be interesting to see how the feds handle this student loan crisis they are building up.
     
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  4. Lesley

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    Thank you for your calculations.

    Considering the $440,000 each of the brothers owe presently contains a fair amount of debt accumulated in dental school, possibly $40,000, the actual amount they borrowed, less interest and origination/administrative fees, for schooling may be closer to $400,000. Their total PAYE payments and tax liability, as you point out over a 20 year period, are $694,000. Very reasonable. They will pay only $294,000 over the actual amount they borrowed to pay for schooling. Their total payments of $694,000 are comparable to approximately a 5%+ interest rate over 20 years on the $400,000 they borrowed. As you stated, at their starting incomes standard repayment plans are not feasible (7.25% at $3,000/month for 30 years or $5,165/month for 10 years). To earn more means these brothers will have to take on considerable and additional business debt and responsibility. If they work together, they will lower total business debt, but they will have to work soundly together in partnership for a very long period of time for it to pay off. Any hiccups in their relationship could prove costly. I think the 20 year AGI of $300K may be a little steep considering we are possibly in a protracted low inflation period when it comes to wages, and additionally insurance companies are lowering fee schedules, the cost of equipment and supplies are increasing, there are an increased amount of dentists graduating, many new schools have opened, and older dentists are retiring later, increasing competition, less patient demand and increasing employee salaries. Any and all in combination may lower the expectations of dentist's AGI's going forward.

    From your calculations, if a borrower goes into PAYE and saves their tax liability and has it ready when it is due, they will pay close to what a borrower on the standard 10 repayment plan pays: $694,000 vs $619,800 - $5,165 x 120 months compared to the 30 year standard payment plan of $3,000 x 360 months, $1,080,000. The advantage of PAYE in this instance is predicated on the borrowers due diligence in saving their tax liability and having it ready when due, and also no changes in treatment of student loan forgiveness by either the IRS or the Department of Education.

    A question, as a large number of people get divorced, if the PAYE/IBR borrower who is saving his/her money to pay off their eventual tax liability divorces before the tax liability is due, does the ex-spouse have rights to half of this asset prior to using it? Can the borrower protect this money from a potential divorce while it is being accumulated so it is never an issue?
     
    #53 Lesley, Oct 4, 2014
    Last edited: Oct 4, 2014
  5. dpmd

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    Don't know how it can be sheltered from divorce, but I wonder if it can be sheltered from the irs (like by having it is a trust along with as many other assets as possible, would retirement accounts be included in assets when considering tax liability)? Seems shady so I bet there is a way (because that is the way our system works, honest people get screwed)
     
  6. user3

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    This is why I think it would be a better idea, once borrowers enter repayment, to:
    -"forgive" the balance (ideally, tax free)
    -seize 10% of borrower's discretionary salary for 20 years
    -allow borrower to "buy out" of wage-seizing by paying whatever the unforigven balance would have been, or grown to.

    Either way, under PAYE borrowers will eventually receive forgiveness. But they will repay the same amount whether that "forgiveness" comes at the beginning or end of the 20 years. So why not organize it this way?
     
  7. Silent Cool

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    Crap. Maybe I should just be a plumber instead.
     
  8. Lesley

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    I didn't think it could be sheltered from divorce either.
     
  9. SigmaFS

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  10. SigmaFS

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    Your assessment of the dental profession is on point. I will add that corporate/chain dentistry and existing dental schools expanding class sizes has added to this competitive environment. Given this backdrop, I did suggest to the brothers to lower their income expectations. Not well received, but I was able to present a modified spreadsheet with some of the following revisions:
    • AGI capped $225k resulting in total 20-year AGI reduced to $3,153,500 from $3,528,500
      • Total PAYE payments under modified AGI = $280,340
      • Amt Forgiven = $798k
      • Tax Liability = $399k
    Both brothers expressed an interest in practice ownership within 2-5 years. An added benefit of PAYE is it increases cash flow which is critical in securing a dental practice loan. A lender will analyze the cash flows of an existing practice (which is preferable to a start-up in saturated markets) to determine if it's cash flows are adequate to meet the financial need of the practice (to include the practice loan debt service, doctor's salary, and office overhead) and the personal financial obligations (including student loan payments which are reduced w/PAYE) of the dentist buyer. The hope is realizing higher income as an owner vs. employee/associate. A similar financial concept is used when apply for a home mortgage - debt-to-income (DTI) ratio. Again, PAYE is expected to lower your DTI increasing your approval rate. Lots of financial balls in air.

    In some cases, PAYE presents financial opportunities that would be otherwise delayed or unattainable in a more traditional repayment. But is sure adds to the financial complexity.
     
  11. Lesley

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    I agree, corporate/chain dentistry and expanding class size, almost all the 60+ dental schools are increasing class size, are also adding to competition in addition to the other things previously stated. There are many reasons that dentistry is not the golden nugget it was several decades or even a decade ago; however, the major benefit of dentistry as a profession over medicine, as things are now, lies in the greater possibility of becoming an owner/practitioner, not only for increased income potential but to have some hope of eventually having some control of your work life, but these benefits often come after several years of pushing through the payments and the steep learning curve of learning to run a business. The fact that PAYE would decrease debt-to-income obligations and increase approval rate on business loans as a major consideration is huge. Income is relative. If these dentists can make their payments, save for their eventual tax liabilities (so critical), take control of their business to make it work for them and not the other way round and live within their means whatever that may be, they will live a happier life than those making more and working for someone else. Just my two cents. For some, the possibility of a projected maximum income of $225,000 after 20 years, after borrowing $400,000+ and paying back close to $700,000+ in addition to rigorous, full time schooling for 8 years with no income during that time, in addition to the stress, strain and financial liability of being a business owner/dentist may not be worth the effort or investment. Based on the 20 year AGI you present $3,153,500 less taxes (1/3 - approximately $1,000,000) less PAYE student loan payments and tax forgiveness liability ( $700,000) net income appears to be $1,453,500 over 20 years, or approximately $72,675/year. The total of $1,700,000 in income taxes and student loan liabilities account for approximately 54% of the 20 year AGI. The practice is an asset that is being built and has value. It's eventual sale and income from the sale, also a taxable event, can not be included due to it's unknown value and if/when this may occur. Recently quite a few dental practices are going for significant discounts compared to yesteryear. Some can't even be sold. Better to go into this eyes wide open.

    SigmaFS thanks for the financial dialog. Very worth it!
     
    #60 Lesley, Oct 5, 2014
    Last edited: Oct 5, 2014
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  12. SigmaFS

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    The financial landscape for health professionals, in general, is changing. And, from the providers' perspective, the financial opportunities aren't what they were. Better to go into this eyes wide open is what we hope, but in my limited experience it is not common. Too many recent grads who don't appreciate the debt implication nor the dynamic markets.

    I greatly appreciate the dialog as well.
     
  13. Lesley

    Lesley Member
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    I wonder if it is not only the recent grads who do not appreciate the debt implications nor the dynamic markets, but possibly people that may have guided them to choose dentistry, such as their parents, relatives, friends and even older dentists who had little or no debt.
     
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  14. Silent Cool

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    Everything you have said in this forum--x10.

    You are right on the money. The supply-demand and cost issues that created success for modern dentists no longer exist. People are clamoring to get into the profession now based on economic circumstances that have vanished during the past 20 years.
     
  15. ChiTownBHawks

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    This is the best thread on SDN. So much relevant information. Keep it up, folks.
     
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  16. Maruko

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    this is so good if it's true!! can you link me to an official source of this info? :)
     
  17. sazerac

    sazerac rye sense of humor
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  18. Ibn Alnafis MD

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  19. BMBiology

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    I dont know how the IRS will tax your forgiveness but I know they include the value of your retirement funds like your 401 k as part of your asset. Here's an example how much much you would have in your 401 k in 20 years: http://www.bloomberg.com/personal-finance/calculators/401k/

    (1) starting salary: 125 k
    (2) % contribution: 5%
    (3) employer match: 5%
    (4) salary increase rate: 3%
    (5) investment rate of return: 8%

    The value of your 401 k: $403,400 (in 20 years)

    If you withdraw your 401 k early then you would not only need to pay income tax but also the 10% penalty.

    If you don't contribute into your 401 k, then you would loss the tax saving and the employer's match.

    Just remember at year 20, the forgiveness amount is added to your salary that year. So for example, if you made 200 k that year and 400 k is foregiven, then 600 k is counted as taxable income. In addition to federal tax, I would also check to see if you would need to pay state, social security and medicare tax as well.
     
  20. Maruko

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    wow, this sucks :eek:
    so they count your 401k as "income" as well? :eek:
    so after 20 years, the amount you'd owe for taxes would be:
    salary + remaining loan + 401k ????
     
  21. sazerac

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    You are getting income and assets confused. The income for that year would be your salary plus the amount of loan forgiveness.

    Form 982 exists to make sure that the taxable amount of forgiveness is never more than your net worth (=assets minus liabilities). A 401k counts as an asset, even if it is inconvenient to access or sell the 401k.

    So the maximum you will be taxed on is income plus loan amount. However, if your net worth is small, then what you would be taxed on would be income plus net worth.
     
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  22. ShowandTell

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    Definitely agree with everyone that this is an awesome thread. I have a question: If someone had the choice of graduating with 200k debt vs. 400k debt( accounting for interest in both cases) and their attending salary was less than 200k in both cases, wouldn't the best option be to do IBR/PAYE in both cases? Since their income is the same in both situations, they would be repaying the same amount of money in loans per month regardless with the same length of time for the repayment period. So then, the only difference in the amount of money the person would pay in total would be the tax on the "forgiven" loan amount at the end of the repayment period. I read through the thread and on my way to the gym, I thought about this, does this all make sense and would this be true?
     
  23. sazerac

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    You are correct that the loan amount paid during your working years could be the same in either case, but the amount of forgiveness would be larger with the larger loan. Thus the tax bill at forgiveness would be larger.
     
  24. SigmaFS

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    Yes, the difference is the taxable amount forgiven. Here are estimates for $200k & $400k outstanding student loan balance with a 50% effective tax rate:

    $200k
    View attachment 191511

    $400k
    View attachment 191513

    I'll add another wrinkle to this discussion. What did you do with the additional $200k of loans, hypothetically speaking? Well, if you invested it for 20 years and it returned a 7% annual rate, your investment value would approximately $774K. PAYE encourages risky behavior.
     
  25. DrMidlife

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    except loan amounts over 200k are in grad plus territory and that's 7.2% territory.
     
  26. ShowandTell

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    Thank you Sigma for the spreadsheet. I have some modifications if you have time to adjust. My previous calculations included the Stafford loan being its maximum $47,000 value every year. After e-mailing the higher costing school, I found that years 1-2 will only allow $42,000 via Stafford and years 3-4 will have the full $47,000 amount. This school has an out of state COA of $89,000 and instate COA of $64,000. For year 1, I will be considered out of state but fortunately, students are eligible to pay instate tuition for years 2-4.

    I've used the FIRST MedLoans calculator on the AAMC website so assuming it's accurate, my loan debt will be $410k upon finishing a 5 year residency. This accounts for $43,000 Stafford/$46,000 Grad PLUS first year and $43,000/$21,000 breakdown for years 2-4. My alternative is my public state school with a COA of $59,000. Once again the same rules apply: $43,000 Stafford for years 1-2 and $47,000 for years 3-4. My total debt for this would be $330k after residency. For some reason, I had in my mind $21,000 tuition/fees for my state school when it was $32,000...

    I asked the higher costing school if they could match my state school and waiting to hear back from that. With the new numbers, however, it looks like ultimately it will be a wash with both schools. Fortunately I have no undergraduate debt. And that's an interesting point about the wrinkle but I don't personally see myself thinking that way if I did have $200k less loans. That $774k after 20 years certainly sounds enticing but what about in between? Would there be a reasonable decision to make on the opportunity cost of investing money vs. ownership of a house, family vacations, etc. while still in my 30's to early 40's?
     
  27. SigmaFS

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    Here's a better screen shot of $200k:
    View attachment 191514
    Just a couple of points for clarification:
    1. You will likely enter PAYE after med school and soon after you've started your residency. As a result, I think you have overestimated the accrued interest.
    2. Total cost of attendance for Med School A is $281,000 (89k + 64k + 64k +64k) and Med School B is $236,000 (59k x 4 years).
    3. Interest rates on the Stafford and Graduate PLUS can change each year for those new loans issued on or after July 1st of each year. Confusing - I'll assume an average interest rate of 7%.
    The interest accrual while in school will not be significantly different (in my eyes) between the two schools. So, I will assume interest accrual Med School A = $45,000 and Med School B = $35,000. Therefore, when entering PAYE, your balances will be Med School A = $326k and Med School B = $271K.

    Med School B = $271k
    upload_2015-4-23_18-59-49.png

    Med School A = $326k
    upload_2015-4-23_19-3-33.png

    I modified the AGI stream based on residency income for 5 years.
     
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  28. ShowandTell

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    Thanks once again. It looks like the total cost of attending Med school A over B would be $150 a month over 20 years assuming I use PAYE. As is obvious, I prefer school A and these numbers have helped me to rationalize that decision. It'd be awesome if I had some money to play around with while in school so I could become somewhat finance literate.
     
  29. skeptastic

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    Three years later, still a fantastic read. Thank for all contributions.
     
  30. TMP-SMX

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    And PSLF is still here and people are using it with tax free debt forgiven. No caps even put in place for future borrowers either.
     
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  31. skeptastic

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    We've gone ahead and planned things out so that we have the funds should something go awry with my wife's PSLF eligibility. If all goes well, fantastic! I am now thinking that I may as well leave in-school deferment status and start making qualified payments as well since under the REPAYE plan we are eligible for, spousal income is always counted. I figure that since I have student loan debt and the payment doesn't change, why not include mine in this deal! Trying to determine if there's something I am missing and thus, a reason I may want to reconsider leaving deferment and going into REPAYE repayment status. I am currently working for a 501(c)(3) company and will be for the next four years as I slowly complete prereqs and keep the family afloat. If I am fortunate enough to get into medical school and complete a residency at a 501(c)(3) company, that will be at least another 3 years of qualified payments. If for some reason I don't get into medical school, I will have began making qualifying payments to the tune of 4 years.

    Any thoughts, anyone? Pros/cons?
     
  32. TMP-SMX

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    It might be a gamble it might not. In medicine don't just do it for PSLF as your upside on income is much higher in private practice. If you really want to be employed or in academics that's just icing on the cake.
     
  33. skeptastic

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    Oh, indeed! I just figured if I'm going to be working for a private nonprofit company for the next 3-4 years anyway, why not get some qualified payments in. I have no idea what will happen in residency, so maybe it won't even be a 501(c)(3) company. Still looking into it, but it does appear to be the case that our student loan payment would be the same whether I am deferred or in repayment status. Interesting situation with this REPAYE plan.
     
  34. TMP-SMX

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    Just keep in mind you can decline in school deferment and continue to make qualifying payments on your previous loans (assuming they are direct loans). The different clock starts on new loans when you enter repayment of those after your grace period.
     
  35. skeptastic

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    I didn't think about that. New loans would have their own clock that starts later. It'll likely be more advantageous for me to never let the interest capitalize and just refi when the time is right and pay them off.
     
  36. TMP-SMX

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    If you refinance, your loan balance is principal plus interest. If you mean capitalization prior to that, it happens when you no longer meet partial financial hardship. This happens to most people 1.5 years after residency.
     
  37. skeptastic

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    Yeah, I meant after I leave deferment. I'm guessing that they won't be approved for financial hardship with my wife's salary and residency pay.
     
  38. TMP-SMX

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    You can easily find that out with this calculator. It depends when you recertify your loans every year and it typically uses your last filed taxes.
     
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  39. skeptastic

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    I appreciate this. Thank you!

    I see... you meant once you no longer qualify for the IDR plan you're on, which would prompt a change of plan and then capitalization of interest. If I'm right, we may be talking about different things. I was speaking about the capitalization that happens when you switch from in-school deferment to a new payment plan. At any rate, I think I've got a fairly decent plan in place and just hope I don't later kick myself for not trying to rack up some years of IDR payments before med school. Either way, I'll live, haha!
     
    #88 skeptastic, Aug 3, 2018
    Last edited: Aug 3, 2018
  40. TMP-SMX

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    We are talking about the same thing. Changing repayment plans, leaving deferment, or no longer qualifying for partial financial hardship all capitalize your loan interest to principal. There's no benefit to in school deferment if you are trying to rack up repayment months for PSLF. There's repayment incentives as well during REPAYE. Your mileage may vary.
     

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