How to calculate the IBR tax consequences Forum

[Kronk]

Final question, I assume money put into a 401K isn't considered an asset for the purposes of loan forgiveness. Am I wrong?

Looks like it. the irs insolvency worksheets has a space for that stuff under assets

http://www.irs.gov/pub/irs-pdf/p4681.pdf

Welp that's a bit of a bitch, but whatever.

Thanks.

[Johann]

wait what - student loans is included on the insolvency calculation - right before forgiveness - so under kronks example $680k of debt and 450k of assets, that would be -230k of assets right? nice find tiago

[Tiago Splitter]

wait what - student loans is included on the insolvency calculation - right before forgiveness - so under kronks example $680k of debt and 450k of assets, that would be -230k of assets right? nice find tiago

oh wow this has potential. somebody call fatduck

[Kronk]

wait what - student loans is included on the insolvency calculation - right before forgiveness - so under kronks example $680k of debt and 450k of assets, that would be -230k of assets right? nice find tiago

oh wow this has potential. somebody call fatduck

*nods*

[AVBucks4239]

I previously made posts on here about how to save for the eventual tax liability that might be of interest to some people (http://top-law-schools.com/forums/viewt ... 5&t=242595).

I've since made a few posts on other forums and have been convinced that just paying my loans ($150,000) off as quickly as possible is my best bet. The cons to IBR were just too much for me:

1. Any calculations are built upon a lot of assumptions that are indeterminable (payments depend entirely upon income, which is almost impossible to forecast).

2. This instability could lead to an incredibly high tax burden, or having to pay back the loan in full after crossing a particular income threshold.

3. Incentivizes me to make less gross income and reduce my adjusted gross income as much as possible.

4. Almost certain to cost more over long term (than just paying it back in 12-15 years), especially if I eventually obtain a higher salary after letting interest balloon.

5. Would require me to file taxes married but separately, thus forgoing substantial deductions annually until loans are paid off (student loan interest deduction; child and dependent care credit; earned income credit; and several other big ones that amount to a ton of money each year).

6. Would have to make plan to prepare for tax liability at year 25 (all of which are less efficient than just paying off the loan).

7. Government could change rules midway through (they pulled the rug out from veterans for God's sake; they could do it to borrowers if they needed the money).

In short, there's just a shitload of cons to IBR. In the short term it seems like the easy way out, but Christ, I'd rather be done with these loans by the time I'm 40 than base almost every financial decision on my student loans until I'm 52. I think I can accomplish this even while matching my 401k (3%; lame but better than nothing), making minimal contributions to a Roth ($1000 per year, maybe), saving for a down payment on a house, etc.


So, now that I've been persuaded the other way, anybody care to run through the numbers and tell me why I'm wrong that IBR is just a scam?

[A. Nony Mouse]

IBR's not a scam, it's just designed for situations where you can't afford to pay back the regular payments (it or PAYE are also required if you're aiming for PSLF). If you can pay off the loans normally, though, you're probably better off doing so.

[lacrossebrother]

.

[Kronk]

IBR's not a scam, it's just designed for situations where you can't afford to pay back the regular payments (it or PAYE are also required if you're aiming for PSLF). If you can pay off the loans normally, though, you're probably better off doing so.

Not sure I agree, although I certainly see where you would have more peace of mind that way. I think given what's been posted here the tax liability may be significantly less than what people are imagining, and it's hard to see where you would end up paying more on IBR or PAYE.

[AVBucks4239]

IBR's not a scam, it's just designed for situations where you can't afford to pay back the regular payments (it or PAYE are also required if you're aiming for PSLF). If you can pay off the loans normally, though, you're probably better off doing so.

Ya, I can't afford the 10 year repayment, but I can afford between the 10 year and extended fixed. I'd rather commit to that than play shell games with my AGI for 25 years.

Also: there's guys on here in BigLaw with debt similar to mine (i.e., making 3x my income) trying to play the IBR game. Just thought I should come back and post that I don't think that's your best bet when you can just get rid of them ASAP.

[A. Nony Mouse]

IBR's not a scam, it's just designed for situations where you can't afford to pay back the regular payments (it or PAYE are also required if you're aiming for PSLF). If you can pay off the loans normally, though, you're probably better off doing so.

Not sure I agree, although I certainly see where you would have more peace of mind that way. I think given what's been posted here the tax liability may be significantly less than what people are imagining, and it's hard to see where you would end up paying more on IBR or PAYE.

Yeah, I was thinking more about peace of mind, which I should have specified. I think that unfortunately we just don't know exactly how this will work out 20-25 years from now, so I can see not wanting to deal with that, especially if you're in biglaw and so don't strictly need it. I honestly don't know how it plays out purely economically.

[Kronk]

I feel like I would have to make a fuckton of money to somehow not qualify for PAYE.

[AVBucks4239]

IBR's not a scam, it's just designed for situations where you can't afford to pay back the regular payments (it or PAYE are also required if you're aiming for PSLF). If you can pay off the loans normally, though, you're probably better off doing so.

Not sure I agree, although I certainly see where you would have more peace of mind that way. I think given what's been posted here the tax liability may be significantly less than what people are imagining, and it's hard to see where you would end up paying more on IBR or PAYE.

I do think the tax liability will be less, but that's not something I'm gambling on since the problem is so far down the road (earliest IBR tax consequences will be in 2032).

What I think might happen even sooner is the feds offering a lower interest rate if loans are consolidated. Elizabeth Warren has been pushing hard for a 4% rate and I can see it happening once more and more and more people enroll in IBR/PAYE. In short, the government might just say, "Hey, we're not getting paid on these loans, let's lower rates so people actually pay this back."

It's a pipe dream, but I think it's more likely in the short term than altering the tax code for student loan discharge.

[AVBucks4239]

I feel like I would have to make a fuckton of money to somehow not qualify for PAYE.

You won't qualify for PAYE once 10% of your AGI (minus 150%) of the poverty threshold exceeds your ten year fixed payment ($3,500 per month?). So ya, until you're pulling in $35,000 (or more) per month, you'll qualify.

Only question is if you start to make $300,000 per year and you're stuck paying a pretty big payment anyway ($1500 or something) until year 20 while having no chance of paying it off because you let the interest get out of control.

[Kronk]

I feel like I would have to make a fuckton of money to somehow not qualify for PAYE.

You won't qualify for PAYE once 10% of your AGI (minus 150%) of the poverty threshold exceeds your ten year fixed payment ($3,500 per month?). So ya, until you're pulling in $35,000 (or more) per month, you'll qualify.

Only question is if you start to make $300,000 per year and you're stuck paying a pretty big payment anyway ($1500 or something) until year 20 while having no chance of paying it off because you let the interest get out of control.

Honestly I doubt I ever make 350k a year but I kind of figure that if I did 1) interest probably wouldn't be that out of control unless the salary raise was violent rather than gradual, e.g. if I went from 70k to 370k. Also, at that point, even if your loans were like 400k it probably wouldnt put you in much financial hardship at all to pay them off on a 400k salary, as much as it would suck to have to revert to a normal repayment plan.

[AVBucks4239]

I feel like I would have to make a fuckton of money to somehow not qualify for PAYE.

You won't qualify for PAYE once 10% of your AGI (minus 150%) of the poverty threshold exceeds your ten year fixed payment ($3,500 per month?). So ya, until you're pulling in $35,000 (or more) per month, you'll qualify.

Only question is if you start to make $300,000 per year and you're stuck paying a pretty big payment anyway ($1500 or something) until year 20 while having no chance of paying it off because you let the interest get out of control.

Honestly I doubt I ever make 350k a year but I kind of figure that if I did 1) interest probably wouldn't be that out of control unless the salary raise was violent rather than gradual, e.g. if I went from 70k to 370k. Also, at that point, even if your loans were like 400k it probably wouldnt put you in much financial hardship at all to pay them off on a 400k salary, as much as it would suck to have to revert to a normal repayment plan.

Point is, what if you make minimum payments for ten years and then go from $100,000 to $150,000 or something (which can happen if you're a partner at a small/mid-size firm and your firm goes from a down year to a great year, for example, getting a new insurance client or something)? Then you might think you should start repaying your loans (since your payment will be above $1,000 anyway), but by then your balance will be huge (maybe $400-450,000). Then you'll have two choices: continue to make PAYE payments for a decade (and continue to file separately so your payments aren't even more), or start paying. And if you start paying, it will take you 5-6 years of very aggressive paying to get your loan back to where it was in the first place.

Conversely, if you pay way above your PAYE payment and then you start making more money, you can aggressively pay that down very quickly.

I mean, I've thought of every way imaginable to "game" the PAYE/IBR system. The two most intelligent guys I know--a CPA and a decently high-up guy at Vanguard--both think I'd be a fool not to put as much towards my loans as I comfortably can for one simple reason: once I do start making more money, I'll be able to take care of my loans very quickly.

[Tiago Splitter]

I mean, I've thought of every way imaginable to "game" the PAYE/IBR system. The two most intelligent guys I know--a CPA and a decently high-up guy at Vanguard--both think I'd be a fool not to put as much towards my loans as I comfortably can for one simple reason: once I do start making more money, I'll be able to take care of my loans very quickly.

1) How much can you really put towards your loans on a 50k salary?

2) The vast majority of CPAs and higher-ups at Vanguard have no idea what PAYE or IBR mean

3) Show them the insolvency worksheet and see what they say. It seems to be telling us that if you have say 300k debt and 250k assets at the end of 20 years there will be no tax bomb. If that's true it's hard to argue that scraping by while paying $500-$1000 a month above the PAYE requirements towards your loans makes any sense at all

4) How confident are you that your salary is going to significantly increase over the next couple decades? You sound really confident and if you're right then paying down aggressively probably is the best option. For someone who doesn't expect to make a ton the calculus is different

[Johann]

The main reason I think everyone should go on PAYE initially with big debt is because interest does not compound, and something like 90% of your payments are initially interest. Paying down interest that doesn't compound really doesn't have a benefit for now as opposed to later. Also, building assets with SA year and stub year as your price point for PAYE repayment is clutch.

AV - I think you should really reassess your loan repayment choices here.

[AVBucks4239]

1) How much can you really put towards your loans on a 50k salary?

2) The vast majority of CPAs and higher-ups at Vanguard have no idea what PAYE or IBR mean

3) Show them the insolvency worksheet and see what they say. It seems to be telling us that if you have say 300k debt and 250k assets at the end of 20 years there will be no tax bomb. If that's true it's hard to argue that scraping by while paying $500-$1000 a month above the PAYE requirements towards your loans makes any sense at all

4) How confident are you that your salary is going to significantly increase over the next couple decades? You sound really confident and if you're right then paying down aggressively probably is the best option. For someone who doesn't expect to make a ton the calculus is different

1) I'm putting about $13-15k per year towards my loans. My GF is about to pay off hers in 3-4 years and is going to start helping me pay off mine (lucky me, I guess).

2) I've had hours and hours of conversation with both of them. Both of them understand it and both of them agree that paying down the debt and maximizing income is my best bet due to the enormous risk involved with making minimum payments.

3) I think no matter what, I'm going to have to pay the loan in my lifetime due to my spouse's income (the estimated payments of our joint income exceeds my extended fixed payment, so I'd have to pay them off in 25 years anyway).

And speaking of that, I just don't think I can file separately for 25 years. The student loan interest rate deduction alone would be $62,500 of deductions lost over 25 years. The child and dependent care credit is $3,000 per kid per year ($75,000, $150,000, $225,000 in potential deductions over 25 years). We'd also lose the married deduction (difference is $8,000 per year, so $200,000 over 25 years). Add to all that that we couldn't contribute to Roth, couldn't get a deduction for a Traditional IRA, etc. On and on. You're talking an absolute shit-ton of money just in tax refunds.

4) I'm not sure about my own ability to drastically increase my income, but I know my spouse's income will come into the picture sooner or later. I also hate, hate, hate that IBR/PAYE somewhat encourage you to keep your AGI down.

The best way to handle debt is to make more money and pay it off.

[AVBucks4239]

The main reason I think everyone should go on PAYE initially with big debt is because interest does not compound, and something like 90% of your payments are initially interest. Paying down interest that doesn't compound really doesn't have a benefit for now as opposed to later. Also, building assets with SA year and stub year as your price point for PAYE repayment is clutch.

AV - I think you should really reassess your loan repayment choices here.

See above. In short, I think I'm right on the fence where I'm going to have to repay my loans anyway. But I also think I'm establishing good financial habits while being dedicated to paying off my loans. My fixed costs are way down and I'm enjoying a much less expensive lifestyle.

I'm still saving $400 per month on a down payment on a house, sending about $80/month to a Roth (so I can have $1,000 per year), matching my 401k (a measly 3%) and have $100 in bullshit/social money each month. I also use credit card rewards to travel and am lucky enough to have friends with season tickets at OSU that invite me to games every year (my most expensive vice).

In short, I'm not slaving away to my loans right now by any stretch. But when I do start making more, I'll have established frugal habits that will hopefully continue and thus allow me to wipe about my loans even faster than I anticipated.

[lacrossebrother]

You could also either just put the difference between PAYE and your current contributions in stocks for the next five years while you see where you think your career is gonna go. Then you could either dump it all back in and pay the rest off at somewhere between like a -3 to +2% gain vs your interest rate...or just continue on PAYE and ride that forgiveness train while hitting your 401k in full

[lacrossebrother]

Check my thinking (this is based on single filer):

401k contribution starting at 18k
Contribution cap growth = 1.5%
conservative CAGR over next 20yrs = 2.5%
401k balance after 20 years, assuming max contribution: ~$530k

In order to get any relief from this law, your PAYE balance needs to be >50% of your wealth, right?
Otherwise you're still getting hit at the marginal tax rate at the end of this thang.
-------
Assumptions: income grows 5% for the first 7 years, and then at 2% for the next 13.

You're maxing your 401k and paying health insurance at like $100/month and shit according to the above assumptions, with fed pov growth also 1.5%.

Loans at 6.5%.
----

Scenarios (in $K):
Starting Salary|Principle|Final Loan Balance|solvency>debt?
160, 200, 38.4, no
160, 300, 390, yes
100, 200, 349, yes
100, 150, 173, no
80, 150, 276.5, no
----
My conclusion is that accumulating wealth in this scenario kind of blows.

The blue you're getting a little relief here i guess...


----
Also note that my compounding is a bit crude. My formula for each year is just balance * 1.065 - amount paid in PAYE in year. Also I didnt account for interest not capitalizing but that's also not a big difference

[lacrossebrother]

Ok, this also creates an insane perverse incentive to have MORE debt

The more debt you can have before forgiveness, the more wealth you can have.

What the fuck.

If Johan is right above this is how this would work:

Assets stay at 400k. Tax rate 35

Debt/pay:
100,35
200,70
300, 35
400, 0

[Tiago Splitter]

It turns out we got a little too excited about the forgiveness stuff. You'll be taxed on the lesser of 1) the amount forgiven or 2) your solvency after the forgiveness

[Kronk]

It turns out we got a little too excited about the forgiveness stuff. You'll be taxed on the lesser of 1) the amount forgiven or 2) your solvency after the forgiveness

still a pretty good deal imo

although that probably means you're paying the full tax bomb if lax's 401K calculations are close to correct and assuming that you've both real estate or made some other sort of investment

[lacrossebrother]

It turns out we got a little too excited about the forgiveness stuff. You'll be taxed on the lesser of 1) the amount forgiven or 2) your solvency after the forgiveness

Ok got it

Is there any decent tax advantaged means for saving for the tax bomb?