Student Loan Repayment Strategies for Health Care Professionals
Managing student loan forgiveness programs is a major element of financial planning for health care professionals. Physicians, dentists, nurse practitioners, and physician assistants, especially, tend to have big student loan balances.
The median student loan balance for recent medical school graduates has now reached $200,000, according to the American Association of Medical Colleges. Nurse practitioner and PA programs from private schools are now pushing well into the six-figure range. The 33-month physician assistant program at the University of Southern California now costs $178,109 to complete.
The Rise of the School Debt Millionaires
Dentists are leaving dental school even deeper in hock than medical doctors: According to the American Dental Association, educational debt for all indebted dental school graduates in the Class of 2018 for public and private dental schools was $251,869 and $326,133, respectively. Additionally, 40% of the Class of 2018 left dental school with $300,000 in medical debt or more.
And believe it or not, at least 141 people have education debt of more than $1 million.
Few of those folks will actually pay off those debts. Most of them will execute the “doctor’s loophole” strategy like Mike Meru. Mike’s a 37-year-0ld orthodontist and USC Dental School graduate profiled in the Wall Street Journal who owes $1 million in student loans. He’s currently earning $255,000 per year, or $21,250 per month, but he’s enrolled in an income-driven repayment program that caps his monthly payments at just $1,589.97.
If he makes all his payments on time remaining balance will be forgiven after 25 years. But because his payments are so low, they don’t even cover the interest on the loan. After 25 years, the taxpayer will be picking up a tab of $2 million – on a degree worth $601,506 in 2014 dollars.
Plan ahead for the tax bill.
The forgiven amount is taxable as ordinary income. Doctor Meru is going to have a heck of an income tax bill on that forgiven $2 million. But with more than 20 years of only paying $1,589.97 on an income of more than $255,000 and growing, and by continuing to build equity in his home and by saving and investing on the side, he will probably be able to pay the income tax bill easily. And it’s still way better than paying the entire principal and interest.
If he had gone to work for a qualifying tax-exempt organization, he wouldn’t have to wait for 25 years. He could have his outstanding debt forgiven after just 10 years of payments, using the Public Service Loan Forgiveness Program. But he’d probably be earning less.
If enough of these stories surface, Congress is probably going to take notice and close the doctor’s loophole.
But existing borrowers will likely be grandfathered in.
What You Can Do
The combination of income-based repayment plans and eventual forgiveness means there are two optimal strategies to choose from for high-debt borrowers – and it doesn’t make sense to try to combine them; For most borrowers, the optimal strategy is an either/ or solution.
Strategy 1: Pay it off fast.
Option one is the direct approach: Aggressively pay down the debt as fast as you can. This generally means refinancing into the lowest interest rate you can find as soon as you can find it and making big, giant, hairy payments on it until it’s gone. This minimizes the interest paid and the lifetime cost of the loan.
The downside of this strategy is that when you refinance a federal student loan, you won’t be able to qualify for the 25-year loan forgiveness program or the 10-year federal public service loan forgiveness program. You may lose access to a number of consumer protections that don’t necessarily apply to private student loans, such as the option to put the loan into a temporary deferment or forbearance arrangement if you are having trouble finding work.
Strategy 2: Maximize forgiveness.
The other option is to pay just the bare minimum – and enrolling in income based repayment plans that have the lowest possible cap that will still qualify for loan forgiveness. In this strategy, you’re paying the absolute bare minimum you can, and counting on eventual student loan forgiveness to pick up the tab.
The lifetime cost of the loan is much, much higher under this strategy. But you don’t pay very much of it. The taxpayer does.
Does the doctor’s loophole create a somewhat perverse set of incentives from a public policy perspective? Yes.
But we don’t make policy here – we just explain the options.
Max your pre-tax contributions
If you are going for strategy number 2, consider throwing everything you can spare into pre-tax savings accounts:
- Traditional IRAs (not Roths) if you qualify;
- SIMPLE IRAs
- SEPs (for self-employment/independent contractor income).
- Solo 401(k)s (also for those of you in private practice, or otherwise with self-employment/independent contractor income and who are owner/operators of your own corporations
- Section 457 deferred compensation plans
- Health Savings Accounts
- Flexible Spending Accounts
If you have your own corporation or LLC, look for other ways to convert ordinary income into reasonable and customary business expenses. Reinvest as much as you can into the business, so you can minimize Schedule C income or self-employment income.
Some planners may even look at the numbers involved in having married people file separate tax returns.
Why? The idea is to get your taxable income – your adjusted gross income after all these deductions – to look as low as possible, on paper, to both the IRS and to the Department of Education.
The reason has to do with the way the federal government calculates minimum payments under income-driven plans
You are expected to make an income-contingent payment of between 10% and 20% of your adjusted gross income over the federal poverty line for your family.
For Income-Based Repayment (IBR) your payment will be 10% to 15% of your adjusted gross income over and above the federal poverty line for your family size.
AGI vs. Gross Income
Your adjusted gross income and your gross income are very different things. Gross income includes everything you took in for the year that wasn’t capital gains income. Your adjusted gross income, or AGI, is your gross income minus all your deductions.
The more deductions you have in the current year, the lower your AGI will be all other things being equal, and consequently the lower your monthly payment.
It doesn’t make much sense to try to keep your gross income low. The more, the merrier, in the long run. The optimum course of action is to keep gross income high in relation to your AGI. The AGI is the bit you pay taxes on, and it’s the bit the government looks at to determine how high your required minimum monthly payments will be under an income-driven repayment plan.
Alimony and Child Support
If you are divorced or are in the process of getting a divorce, try to categorize settlement payments as alimony payments rather than child support. Especially if you’re in a higher tax bracket than your ex. Alimony payments are taxable to the recipient, and a tax deduction for the payor. So it gets that income off your books and onto your ex’s, where it won’t count against you when calculating your required income-contingent payment for the year.
With child support, it’s just the opposite: There’s no tax deduction for the payor, but the alimony payments received are taxable as income
So if you’re receiving payments pursuant to a divorce, try to negotiate a settlement in which they are characterized as child support payments, rather than alimony – especially if you’re in a higher tax bracket than your ex.
Tips and techniques
Filing separate tax returns as a married couple may be an extreme solution. You may lose a lot of other deduction opportunities by filing separately. But it may make sense if you have a lot riding on the income-driven repayment calculation if one spouse has a lot of medical expenses in a given year, and you want to be able to deduct as much of those expenses as possible or both.
Buy a home, rather than rent. This is because you can deduct home loan interest, but you can’t deduct any part of your rent on a personal residence.
Start a small business retirement plan.
Start a solo 401(k) or SEP IRA, if you own your own company or you have self-employment income. Unlike IRAs, none of these plans are means-tested, Money you contribute to either of these retirement plans is pre-tax. It’s invested for your future and compounding for you over time. Meanwhile, it’s not counted against you in the income-driven repayment calculation.
This a potentially huge benefit of having your own business: If you own your own business or private practice, you can hire non-spouse family members to help you run it. Every cent you pay them in compensation helps reduce your AGI because it gets income off your individual tax return or Schedule C and onto their personal returns. Meanwhile, the money stays in the family.
Take your losses.
If you have investments that have taken a loss, go ahead and sell them and do something else more productive with the money. You can use capital losses to offset any gains you realized during the year, and then up to $3,000 in income per year.
Note: You can’t just sell an investment at a loss and then turn around and buy the substantially identical thing immediately after. You have to wait at least 30 days before you can buy the same thing, or you can’t take the deduction, under so-called “wash sale” rules. But you can buy something very similar! For example, you can sell the Vanguard 500 fund and then buy Fidelity 500 Index fund, which has all the same companies in it, with substantially the same weightings!
Buy municipal bonds from your state.
This can be a good move for those in hire income tax brackets — especially if your state has an income tax. Interest from municipal bonds is generally free of federal and state tax (with certain exceptions for private activity bonds if you’re subject to the AMT). This also helps lower your AGI.
Track your miles. You can and should deduct for every mile you drive in your personal vehicle for business reasons. This includes mileage you drive from your principal place of business (your office) to hospitals and clinics, rehab facilities and anywhere you check on or meet with patients and staff, attend in-service or CME courses, conventions, etc. You can’t deduct mileage from your home to your principal place of business, but you can deduct miles you drive during the course of business day once you get to your office. As of 2019, you can deduct 58 cents per mile driven in your own vehicle for business purposes. That adds up surprisingly fast – and there are GPS apps that make this process a snap.
Don’t cross the streams!
Every situation is different. But if you select strategy 2, it doesn’t do you any good to try to make extra payments on a loan that will eventually be forgiven anyway. You can’t bend the space-time continuum to make 10 years or 25 years come sooner. Paying ahead doesn’t do you any favors in the federal student loan forgiveness context. You don’t get brownie points.
Think beyond Public Service Loan Forgiveness.
The Federal Public Service Loan Forgiveness program is a great program – especially for doctors, dentists, and other high-debt professions. It can also be a very good fit for lower-earning professions such as teaching and social work. These people often work their whole careers with state or non-profit organizations that qualify for the federal PSLF program.
But it’s not the only one out there.
For example, many states have their own loan forgiveness programs specifically for health care workers identified shortage areas, under the auspices of the federal Health Resources and Services Administration (HRSA) State Loan Repayment Program.
For information on medical professional student loan forgiveness programs specific to your state, click here, and scroll down to find your state.
You can also scout out which states have the most advantageous student loan forgiveness programs for your situation.
Jason Van Steenwyk is an experienced financial industry reporter and writer. He is a former staff reporter for Mutual Funds, and has been published in SeekingAlpha, Nasdaq.com, NerdWallet, Value Penguin, RealEstate.com, WealthManagement.com, Senior Market Advisor, Life and Health Pro and many other outlets over the past two decades. He is also an avid fiddle player and guitarist. He lives in Orlando, Florida.