Due to the extremely high level of student debt that most physicians hold, many are eligible for several types of forbearance and debt-reduction programs. The difficulty lies in choosing among them all.
This article focuses on one of the more common debt programs for U.S.-based physicians, the federal 10-Year Public Service Loan Forgiveness (PSLF) program, and the differing repayment options involved.
PSLF Program 101
This PSLF is a federal program that can cover virtually any field of practice. Most federal student loans are eligible for the program, assuming you borrowed through the Stafford, Perkins or other federally backed programs. Although PSLF benefits are currently not taxable, this could change in the future.
To qualify for the PSLF, you must work for a federal, state, or local government agency OR a non-profit with 501c3 status. Certain non-profits that aren’t 501c3s are also eligible.
Don’t miss this point: if you are employed by a hospital that has a non-profit 501c3 status, you are probably eligible for this program! Make sure to determine whether the arm that you are working for is a non-profit or for-profit, however. Some non-profit hospitals can have a for-profit subsidiary for tax reasons.
Why you should sign up
Per the name, the PSLF is a 10-year program. The federal government will not forgive the balance until the end of the program. Because of this, you should sign up as early as residency or fellowship, even if you're not sure what type of practice you'll join after training. You don't face any penalties for withdrawing from the program later, due to an ineligible employer.
While you are employed full-time for a public service organization, you must make 120 on-time, full monthly payments. Note that this includes payments during residency and fellowship, although your monthly payments are substantially lower during training.
Case #1: Training followed by for-profit job
If you sign up for the program during residency or fellowship, make the required monthly payments, then end up joining a for-profit practice, you don't qualify for loan forgiveness, but you face no penalty for withdrawing. At the same time, you've saved yourself interest through the ongoing payments.
Case #2: Training followed by non-profit job
If you are in residency for three years, you will only have seven years remaining on payments when you finish residency. But if you have a fellowship for three years in addition to three years of residency, you only have four years remaining on payments!
Bottom line: make sure you to enroll while you are in residency and fellowship!
How the PSLF Works
If you have Federal Family Education and/or Perkins loans, you need to consolidate them into a direct consolidation loan to take advantage of PSLF program. This process takes one to three months to complete depending upon your situation.
As you complete the consolidation process, you must pick a repayment program. The four most common programs are the income-based repayment (IBR), pay-as-you-earn (PER), income-contingent repayment (ICR) and 10-year standard repayment plans. In this article, we’ll focus on IBR and PER plans, as they require lower payments in residency and fellowship, which can lead to greater debt forgiveness.
Parsing the Plans: IBR vs. PER
IBR and PER plans both accomplish the same goal: minimizing your student debt payments while in residency/fellowship and then paying back your student loans at a higher rate once you are making more money.
Under the IBR plan, you commit to a monthly payment of 15 percent of your discretionary income; under PER, you commit to only 10 percent of your discretionary income. Note that discretionary income has a very specific definition: your after-tax income minus poverty guidelines published by the government.
The government will also consider your household — i.e. spouse, spousal school loans, kids, etc., as these affect the poverty guidelines. And how do they determine your income? By looking at your tax return.
This is an important distinction because the government is purely looking at your “adjusted gross income.” This means that they are taking a snapshot of your income after pre-tax deductions for 401k/403b contributions, health-savings accounts and deductions for any active business losses.
The higher you can contribute in those areas, the lower your monthly obligation will be.
Meeting PSLF Program Requirements
Once you’ve picked a repayment plan, you need to start making on-time, monthly payments for the ensuing 120 months.
At the same time, make sure that every year you complete the employment certification form and submit it to FedLoan Servicing (PHEAA), the PSLF servicer, following the instructions on the form. You must get your employer's certification on the form each time. Any time you change jobs, you’ll also need to complete the form.
FedLoan Servicing will review your employment-certification form, ensure that it is complete and, based on the information provided by your employer, determine whether your employment qualifies for the PSLF Program.
What Will Happen After Residency/Fellowship
If you ended your residency/fellowship in June and started your first contract in July, you would likely not have to start higher payments until the following year. For example, if you finished your residency in June 2013, your higher payments will not take effect until after January 2014. Then, payments will increase even more substantially the following year. In this example, it would be after January 2015 when you have a full year of higher income under your belt.
However, the payments do not take into consideration your overall student loan debt (including undergraduate and medical school debt), your age or whether you have a car loan, mortgage, etc.
The table below was created using the calculators from the Federal Student Aid website. It assumes that the person (1) is married, (2) has no kids or spousal school loans, (3) the original loans were $20,000 to $30,000 below the current loan amount and (4) the loans carry an interest rate of 6.8 percent.
While you could like easily qualify for IBR while in residency, the calculator on the website doesn’t allow one to calculate the payment at a $200,000 income level for the $150,000 loan amount. However, we can safely assume that the payment should be $2,216/month in the example below, because the monthly payment fluctuates with compensation, but not with the loan amount.
||*Does not qualify
See the tremendous difference between IBR and PER? It is more than $500/month at the $150,000 compensation level and more than $700/month at the $200,000 compensation level! Note that the IBR or PER amount does not change as the loan amount goes up. This is because the payment depends primarily on income.
There is one big caveat between the two programs, however. To qualify for PER, you must have been a new borrower as of Oct. 1, 2007, or later.
Tying Forgiveness and Repayment All Together After Residency/Fellowship
How does all of this tie in with loan-forgiveness programs? Let’s take a look at an example where two young ophthalmologists, Dr. Smith and Dr. Patel, both started PSLF at the very start of residency. We’ll assume each had an equal amount of student debt coming out of medical school.
Dr. Smith has been in residency for three years, has made 36 payments towards PSLF and went right into practice. He is making $150,000 per year.
Meanwhile, Dr. Patel has also been in residency for three years, has made 36 payments towards PSLF and also just entered into practice. He is now making $200,000 per year.
Let’s examine the difference of what would happen if each of them enrolled in IBR or PER at the start of residency.
The table below adds up the monthly payments from the previous example and multiplies them over seven years. We’ll assume no increase in salary, to keep it simple and flat. The lifetime payments in the table represent the combination of interest and principal over those seven years.
||*Does not qualify
At the end of the seven years (assuming continued non-profit employment), the remaining portion of both doctors’ debt would be forgiven.
With $250,000 of loans and $150,000 worth of compensation, Dr. Smith would have paid about $90,000 in PER after seven years in practice, vs. $130,000 in IBR.
Meanwhile, at an interest rate of 6.8 percent, Dr. Smith would have been accruing interest of about $17,000 annually or $1,416 per month. With PER, he would have been paying $1,478 per month, barely tapping into principal.
This translates to roughly $225,000 worth of forgiveness with IBR versus $265,000 of forgiveness with PER. This is why PER is superior to IBR when you tie in the student debt-forgiveness programs with them.
Giving up this gift is the tax equivalent of almost $360,000 or $51,000 per year over seven years, assuming a 30% tax bracket.
Even with IBR, Dr. Smith would still have debt forgiveness of nearly $200,000 — the approximate tax equivalent of $285,000. Either is wonderful, but PER is better for debt-forgiveness purposes!
As a reminder, to qualify for PER, you must have student debt that originated after October 2007. This will likely start effecting residents and fellows who started in 2012 and even more so over the next few years.
As a physician, you’ve made a commitment to helping others and your community. Make a similar commitment to your finances.
If you are working for a non-profit entity, PER is probably a better option unless you don’t qualify due to the origination of your student debt. In that case, IBR would still be a fine choice.
I would strongly suggest you not put extra payments towards your debts if you are already enrolled in the PSLF program, unless you think you may not be ready to make a 10-year commitment to staying in the non-profit community.
If you are currently working for a non-profit and considering transitioning to a for-profit practice after residency, IBR would be my recommendation. Keep in mind that you can make extra payments beyond the minimum IBR requires to pay it off sooner once you are in practice.
If, as a young physician, you focus on paying off your debts, save for a rainy day, live within your means and put money away for retirement, you can then do the things you’ve long dreamed of doing and be well down the road to financial independence.
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About the author: Dave Denniston, CFA, is a professional wealth manager and financial advisor located in Bloomington, Minn. He is also the author of 5 Steps to Get out of Debt for Physicians and 45 Secrets to Financing a College Education. You can contact him at www.daviddenniston.com/young-physicians.