Prepping for the 25 year Fed Loan Forgiveness tax bomb Forum

Discuss various money matters here. Loans (federal and private), scholarships, lottery winnings, or other school finance related information and queries.
Post Reply
User avatar
BruceWayne

Gold
Posts: 2034
Joined: Sat Aug 14, 2010 9:36 pm

Prepping for the 25 year Fed Loan Forgiveness tax bomb

Post by BruceWayne » Wed Jul 23, 2014 1:41 pm

Can people familiar with finance explain the nuances of saving in advance/planning for the large tax bomb that comes after using the fed loan forgiveness 25 year option that applies to those working private sector legal jobs?

User avatar
swampman

Bronze
Posts: 498
Joined: Fri Sep 13, 2013 3:48 pm

Re: Prepping for the 25 year Fed Loan Forgiveness tax bomb

Post by swampman » Wed Jul 23, 2014 6:35 pm

I have a finance background but not a tax background, so grain of salt. The basics: Any debt cancelled will be be counted as income and taxed at the state and federal marginal tax rates, except to the degree that you are insolvent. That is, take your liabilities (student loans, mortgage, credit cards) and subtract your assets (house, car, retirement, jewelry etc), and that amount of cancelled debt will be untaxed.

So, since compound interest is a bitch, EDIT: Interest won't capitalize while on PAYE/IBR, thus no compounding interest. Your final debt will likely be much lower than in this example so insolvency is very unlikely lets say at 25 years you have $600k in student loans. If the value of your assets is only $250k and you have $700k in total debts (including the students loans) then the first $450k of cancelled student debt will be tax-free. You'll only pay income tax on $150,000.

However if you've done okay for yourself IBR/PAYE will have kept the debt from ballooning, and you'll have paid down your mortgage and saved for retirement (which hopefully will be the case after 25 years) so you should expect to pay income tax on the full amount. A good chunk of this will fall into the higher marginal tax rates, which are 33-40% plus another 0-10% depending on the state. And these rates could go up in the next 25 years.

Assuming a solid income it doesn't look like there are many loopholes here. Put post-tax money in conservative investments and save more than you think you'll need in case taxes go up. Most importantly, try to reside in a state with little or no income tax when the debt is cancelled.
Last edited by swampman on Wed Jul 23, 2014 6:58 pm, edited 1 time in total.

NYSprague

Silver
Posts: 830
Joined: Wed Apr 16, 2014 2:33 pm

Re: Prepping for the 25 year Fed Loan Forgiveness tax bomb

Post by NYSprague » Wed Jul 23, 2014 6:39 pm

Isn't there a cap on interest total? This cap has been mentioned in other threads. I don't know the answer to this question and I find conflicting information.

User avatar
swampman

Bronze
Posts: 498
Joined: Fri Sep 13, 2013 3:48 pm

Re: Prepping for the 25 year Fed Loan Forgiveness tax bomb

Post by swampman » Wed Jul 23, 2014 6:53 pm

NYSprague wrote:Isn't there a cap on interest total? This cap has been mentioned in other threads. I don't know the answer to this question and I find conflicting information.
Forgot about that! There's no cap on total interest, but interest won't be capitalized as long as you stay on PAYE/IBR. If you leave PAYE only interest up to 10% of the principal will capitalize (I don't believe IBR has this provision). So there's no compounding interest as long as you stay on PAYE/IBR, which greatly reduces the amount that will have to be forgiven.

Example for non-financy people:
If you graduate with 200k in debt with an 8% interest rate, 16k in interest will accumulate each year in a separate "pile" from the 200k principal. That interest will keep piling up every year, 16k, 32k, 48k etc, but you won't pay interest on that separate pile, only on the 200k principal. Your IBR/PAYE payments of 10-15% of your income will go towards that pile of interest before you start paying down the principal. If you leave PAYE, only 20k of from that pile would immediately capitalize (though you would still have to pay off whatever remained in that pile), so you would now be paying 8% of $220k every year, and any additional interest that accumulates would be added to that 220k and keep compounding.
Last edited by swampman on Wed Jul 23, 2014 7:15 pm, edited 1 time in total.

User avatar
Johann

Diamond
Posts: 19704
Joined: Wed Mar 12, 2014 4:25 pm

Re: Prepping for the 25 year Fed Loan Forgiveness tax bomb

Post by Johann » Wed Jul 23, 2014 7:01 pm

Likely gonna be legislated away. The only planning I'd worry about at this point are maxing out retirement accounts yearly because they are largely untouchable. 5 years before bomb if it's still in place I'd look into some tricky shit with trusts or taking out a huge mortgage to make you insolvent. If all else fails and tax bomb is fast approaching I'd try to refinance and then default on that. Better to be in debt at that age to a private company than the irs.

Want to continue reading?

Register now to search topics and post comments!

Absolutely FREE!


User avatar
Johann

Diamond
Posts: 19704
Joined: Wed Mar 12, 2014 4:25 pm

Re: Prepping for the 25 year Fed Loan Forgiveness tax bomb

Post by Johann » Wed Jul 23, 2014 7:11 pm

Another thought that passed my mind but I hadn't read the rules for - I think it's up to us to affirmatively apply for our loan to be discharged. It may be best after 25 years and nearing retirement just to never apply for the forgiveness. Keep making the small payments monthly and then retire and have 0 income so no payment.

User avatar
swampman

Bronze
Posts: 498
Joined: Fri Sep 13, 2013 3:48 pm

Re: Prepping for the 25 year Fed Loan Forgiveness tax bomb

Post by swampman » Wed Jul 23, 2014 7:23 pm

JohannDeMann wrote:The only planning I'd worry about at this point are maxing out retirement accounts yearly because they are largely untouchable. 5 years before bomb if it's still in place I'd look into some tricky shit with trusts or taking out a huge mortgage to make you insolvent. If all else fails and tax bomb is fast approaching I'd try to refinance and then default on that. Better to be in debt at that age to a private company than the irs.
This dangerously wrong. The IRS can and will take your retirement accounts if you owe them money, as well as put liens on your home.
As to refinancing and defaulting, the private companies will still come after any assets you have. If your financial situation is so bad that you would consider defaulting on non-dischargeable debt then you will probably be covered by the insolvency rules I talked about above and you wouldn't actually owe the IRS any money. Also if your income and assets are that low a private company is not likely to want to refinance your loans, and if you did so with the intention of defaulting you would be facing criminal charges and disbarment.

User avatar
Johann

Diamond
Posts: 19704
Joined: Wed Mar 12, 2014 4:25 pm

Re: Prepping for the 25 year Fed Loan Forgiveness tax bomb

Post by Johann » Wed Jul 23, 2014 7:30 pm

Basically you get to keep retirement accounts if you declare bankruptcy. I wouldn't rule out bankruptcy covering student loans in 25 years. It's the last place the fed govt will go to get money from a debtor.

True none of them are good plans. My main point is at this point penciling in plans is dumb because we know nothing about what the landscape in 25 years will be. Anything you plan for at this point has about as good of a chance as being detrimental as helpful.

Op - chill out. Stack away in retirement and savings accounts. Pay the minimum payment and try not to check your loan balance. Reassess in 10 years. It's gonna be alright.

User avatar
twenty

Gold
Posts: 3189
Joined: Wed Jan 11, 2012 1:17 pm

Re: Prepping for the 25 year Fed Loan Forgiveness tax bomb

Post by twenty » Wed Jul 23, 2014 7:49 pm

At the risk of sounding like a complete asshat (and that's not even remotely how I want to come across) it might be worth factoring in you could pick up a long-term PI/government gig and then take advantage of the tax-bomb-less PSLF. Even 15 years from now, if you could get a PSLF-qualifying gig for the remainder of your career, you'd be ahead of the game.

Want to continue reading?

Register for access!

Did I mention it was FREE ?


Big Dog

Silver
Posts: 1205
Joined: Wed Dec 16, 2009 9:34 pm

Re: Prepping for the 25 year Fed Loan Forgiveness tax bomb

Post by Big Dog » Wed Jul 23, 2014 8:18 pm

Likely gonna be legislated away.
Other than wishing for it to happen, there is absolutely no reason to believe that to be correct. (OTOH, if Elizabeth Warren becomes Prez, then it is highly likely to happen...)

User avatar
BruceWayne

Gold
Posts: 2034
Joined: Sat Aug 14, 2010 9:36 pm

Re: Prepping for the 25 year Fed Loan Forgiveness tax bomb

Post by BruceWayne » Thu Jul 24, 2014 10:16 am

Great replies thanks.

johnrafael30

New
Posts: 1
Joined: Fri Oct 31, 2014 9:50 pm

Re: Prepping for the 25 year Fed Loan Forgiveness tax bomb

Post by johnrafael30 » Fri Oct 31, 2014 10:00 pm

SPAM

User avatar
AVBucks4239

Silver
Posts: 1095
Joined: Wed Feb 10, 2010 11:37 pm

Re: Prepping for the 25 year Fed Loan Forgiveness tax bomb

Post by AVBucks4239 » Thu Nov 13, 2014 6:06 pm

I'll just add that dinkytown.net might be a great resource for you to consider in the "Should I save or should I pay off my debt" calculus. It's proved to be an amazing tool and I'd highly recommend it to anyone.

Register now!

Resources to assist law school applicants, students & graduates.

It's still FREE!


Post Reply

Return to “Financial Aid”