Should I contribute to a traditional or a Roth IRA?
This is a big question I get asked fairly frequently. And really, the conversation expands beyond individual retirement accounts. The decision whether to invest on a tax deferred or tax exempt basis is one you'll likely make many times over your investing career. Some people prefer a exempt account to "get taxes out of the way", while others prefer to defer taxes as long as possible in order to "let their money work for them".
In this post we'll explore the topic and discuss which situations may be best for either strategy. But first, let's review exactly what tax deferred and tax exempt investing actually are.
It's no secret that most doctors graduate from medical school with mountains of student loan debt. $183,000 on average in fact, according to the AAMC. And while its easy to assume that you'll make plenty of money to repay student loans once you become an attending physician, there are many forgiveness and repayment assistance options available to help.
This handbook is a comprehensive review of student loan forgiveness options available to doctors. Even if you expect to have the capacity to repay your loans, forgiveness and repayment assistance can help you get there faster, with less pressure on your bank account.
Many doctors these days are pursuing public service loan forgiveness (PSLF). And for good reason. By working at a qualified employer for 10 years, PSLF forgives your federal loans – tax free. Only federal direct loans qualify for PSLF though. FFEL, Perkins, and private loans do not. For this reason, if you're considering PSLF make sure you consolidate any FFEL or Perkins loans right after you graduate, since federal consolidation loans do qualify for the program. Private loans are simply not an option.
For doctors, this means that work in a tax-exempt hospital or medical school will likely qualify. To find out, you can submit an Employment Certification Form with the Department of Education. Rather than working for ten years and hoping your employment qualifies for forgiveness, the DoE will verify your status with this form. The form requires the signature of someone familiar with your service record. Since tracking down the signatures of old bosses can be a major pain, best practices are to submit it every few years or whenever you change employers.
Technically you'll need to make 120 qualifying monthly payments while working at a qualified employer in order to receive PSLF. A qualifying payment is one made under an income driven repayment plan. The standard 10-year repayment option does qualify for PSLF, but after making 120 payments there wouldn't be anything left to forgive.
If you're interested in PSLF, run the numbers on the various income driven repayment options and find the one where you pay the very least out of pocket over the next ten years. Once you make the 120 qualifying payments, you'll need to submit a an official PSLF application in order to receive forgiveness.
The combination of PSLF and several of the income driven repayment options creates a nice "loophole" for doctors. Pay As You Earn (PAYE) and Income Based Repayment (IBR) calculate your minimum monthly payments based on a percentage of your discretionary income. Residents earning around $55,000 per year with $183,000 in debt from med school certainly qualify.
The catch with PAYE and IBR is that there's cap on monthly payments. Even though your income will jump significantly as an attending, your monthly payments will never be more than what they would have been under the standard 10-year repayment plan when you entered the program.
The Public Service Loan Forgiveness (or PSLF) program forgives any of your student loans remaining after making 120 qualifying payments while working full time for a qualifying employer. While the income driven repayment options also offer forgiveness after 20 or 25 years of qualifying payments, forgiveness under these plans is counted as taxable income. Forgiveness under PSLF is completely tax free. Win-win!
Any government organizations. This includes state, federal, and local governments.
Non-profit organizations that qualify for tax exempt treatment under 501(c)(3).
Other types of non-profit organizations that provide certain types of public services.
Some estimates count 33 million public service employees who could qualify for PSLF. As of June, 2015, only 335,520 people were enrolled in the program, or barely more than 1%.
What is Pay As You Earn Student Loan Repayment?
The Pay As You Earn (or PAYE) student loan repayment program was passed in December of 2012, and is President Obama's spin on income driven repayment. Understanding that student borrowers faced significant challenges once they entered repayment, the President used PAYE to improve on the preexisting Income Based Repayment in several different ways.
Although it has rather strict qualification standards (only the classes of 2012 and later qualify), PAYE is a terrific option for those who can use it.
Pay As You Earn is just like Income Based Repayment in how your monthly payments are calculated. Monthly payments under PAYE are 10% of your discretionary income, which is the difference between your adjusted gross income and 150% of the poverty line in your area.
Again, poverty guidelines are set by the Department of Health and Human Services, and are updated annually. You can look up the poverty line in your area here.
Like IBR, PAYE has an interest subsidy component and forgiveness of any remaining balances after 20 years of qualifying payments. But, remember that any amount forgiven is taxable as income unless under the public service loan forgiveness program. If you're counting on forgiveness outside of PSLF, it's best to plan for the resulting tax bill.
What is Income Contingent Student Loan Repayment?
Income contingent repayment (or ICR) is the oldest of the four income driven student loan repayment options. Originally passed by Congress in 1994, ICR was the government's first attempt to reduce the burden of student loans by tying monthly payments to borrowers' adjusted gross income.
While helpful when it was first introduced, ICR has been overshadowed by the other four options rolled out since then. Today, ICR is all but obsolete unless there is a Parent PLUS Loan involved.
ICR gives borrowers another option if the monthly payments from the 10 year standard repayment plan are too costly. When borrowers enter ICR, their monthly payment is calculated based on their adjusted gross income and the amount they'd otherwise pay over a 12 year repayment plan.
This income percentage factor ranges from 55% to 200% based on adjusted gross income: the lower your AGI, the lower the income factor and the lower the output. It's updated each July 1st by the Department of Education, and can be found with a quick Google search.
An interesting point to note here is that the income percentage factor ranges all the way up to 200%. It's possible (whether using 20% of discretionary income or the second calculation) for your monthly payment under ICR to exceed what it would be under a standard 10 year repayment plan. This differs from IBR and PAYE, where your payment is capped when this happens (at what it would have been under the standard 10-year plan).
Income based student loan repayment (or IBR) is one of the four income based repayment options that the federal government offers to help borrowers reduce monthly payments on their debt. IBR is a great option if you don't qualify for the Pay as You Earn (PAYE) program, and aren't a good fit for the Revised Pay as You Earn (REPAYE) program. While only available on certain federal student loans, the program is a wonderful benefit to many lower income borrowers.
What is Income Based Student Loan Repayment?
The income based repayment option (IBR) was originally passed by Congress in 2007, but didn't become effective until 2009. It's objective was to provide a more affordable student loan repayment option to low income borrowers. The plan improved on the preexisting income contingent repayment option (ICR) by lowering minimum monthly payments from 20% of discretionary income to 15%.
Then in 2014, IBR was revised. For new borrowers as of July 1st, 2014, monthly minimum payments were reduced from 15% of discretionary income to 10%, and the forgiveness period was shortened from 25 years to 20.
IBR was a significant improvement over the ICR repayment option. But today, there are two additional income driven repayment options (REPAYE and PAYE) that are a better choice for most borrowers. But due to PAYE's qualification standards and REPAYE's mandatory inclusion of spousal income, IBR remains a viable option for many others.
Like all income based repayment options, IBR gives borrowers an alternative if the minimum monthly payment on the 10 year repayment plan is too much. For example, let's say you're a new graduate and have accumulated $100,000 in federal student loan debt. You're about to start work at job that pays $50,000 per year, and the interest rate on your loans is 6%.
Helping loved ones finance the cost of education is a wonderful & long lasting gift. But when you build this type of gift into your estate planning aspirations, the more traditional vehicles can be limiting in many ways.
529 plans and Coverdell ESAs are two of the most popular options, but the accounts can be rigid and limiting. If your objectives are more unique, say you want to help multiple beneficiaries or include other requirements for access, you'll need a more customized solution.
Enter the educational trust fund. Educational trust funds give you complete control over how your gift is to be managed and distributed. If your gifting strategy is even marginally complex, an educational trust fund might be your best option.
When contributing to the 529 or Coverdell account of a loved one, you're faced with numerous and rigid restrictions. There are contribution limits, there are limitations on what the funds can be used for, and there are restrictions on portability and who may use the funds. They provide a great way to save for college on a tax advantaged basis, but there's not much room to customize.