Dear Dr. Debt: I fear I won't qualify for loan cancellation
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Dear Dr. Debt is a new monthly advice column about student-debt management in the veterinary community. It is adapted from Veterinary Information Network and VIN Foundation message boards where veterinarians and veterinary students ask questions and get answers to help them approach borrowing and repayment strategically.
Over the years, thousands of these online conversations have enabled VIN members to learn the good, bad and ugly aspects of student loans. With Dear Dr. Debt, the VIN News Service extends the conversation to the wider veterinary community, featuring advice from student debt expert Dr. Tony Bartels. This month's scenario illustrates the complexity of student debt considerations.
I graduated in 2015 from a veterinary college in the U.S. I am married, and my spouse and I file our taxes separately to keep my student loan payment low. We live in a community property state.
Recently, I signed a two-year contract to work at a companion animal practice and received a $100,000 signing bonus. If I leave my job before the contract ends, I will have to repay the bonus, prorated. I plan to hold onto the money for a while for this reason.
Here is a breakdown of my finances:
Federal student loan principal: $129,015
Unpaid interest balance: $15,726
Student loan interest rate: 6.23%
Repayment plan or strategy: Pay As You Earn (income-driven repayment)
Monthly payment: $479
Expected remaining time to repay the loan: Not sure
Other debt: $162,000 mortgage; $25,200 auto loan; $6,000 credit card balance
Tax status: Married filing separately
Adjusted gross income (AGI) from most recent return: $144,987
Spouse income: $25,000
My main concern is whether I am eligible for the Biden administration's $20,000 federal student loan cancellation plan, and what, if anything, I can do to make sure I qualify.
Other family information: My stepdaughter lives with us, and my spouse lists her as a dependent on his taxes. For several years, we've filed separately to help lower my monthly PAYE payments, considering that the program uses an income-based system to calculate them.
But we're considering changing our filing status to married filing jointly so I can qualify for the $20,000 debt relief plan. As I understand it, income thresholds for eligibility are $125,000 for single or married borrowers like me, who file their taxes separately, or $250,000 for married borrowers filing jointly in 2021 or 2022.
Also, in light of my recent bonus, I probably need to change my loan-repayment strategy. The way I see it, filing jointly will cause my student loan payment to increase significantly under PAYE, so it doesn't seem like it makes much sense to stay on an income-driven repayment plan. But if we keep our tax status as married filing separately, just to get lower PAYE monthly payments, it seems that I would miss out on $20,000 of debt relief.
For this reason, my focus has switched from working toward and saving for forgiveness to refinancing the remaining balance into a lower-interest loan that can actually be paid off. Plus, the PAYE forgiveness plan, which I've been enrolled in for seven years, has always been stressful to me because there is no guarantee I will qualify when I apply for forgiveness after 20 years of monthly payments. Honestly, I don't have 100% faith that the government will honor the plan by forgiving my remaining loan balance. It would give me peace of mind to not have to rely on forgiveness, which necessitates using the signing bonus to pay down my loans to a more manageable balance.
I could pay off my credit cards but my student loans have always felt like such a burden. And if I am no longer relying on forgiveness, I do not have to save for the income tax assessed by the IRS on forgiven balances, and I can redirect that money to other areas.
— A Lot to Consider
Dear A Lot,
First, congratulations on that sign-on bonus. That's incredible!
There are some complicated and overlapping financial concepts in your questions. Let's evaluate them one by one.
I understand your concerns, given the recent changes in your circumstances. It sounds to me like many of these changes have improved your overall finances, which is great news! Now, let's help you keep more of that additional income by exploring how recent student loan announcements interact with your PAYE repayment strategy. I think there is a pretty strong financial case for you to remain on your income-driven pathway.
As you probably know, interest and payments on your federally held student loans have been suspended during a special pandemic forbearance period that began on March 13, 2020, and has recently been extended through June 30, 2023, or whenever the U.S. Supreme Court rules on the cancellation benefits. If the court rules before June 30, payments will resume 60 days after the date of the decision. If not, payments will resume no later than 60 days after June 30.
The timing is excellent for your situation. Not only will your student loans not require payment or accrue interest for potentially another nine months, but you will have continued flexibility to address some other financial areas you listed. The extension also buys you valuable time to work through that sign-on bonus period with no additional cost to your student loans.
Meanwhile, you're still earning PAYE forgiveness credit! As of November, you've made seven years of qualifying PAYE payments. With the recent extension, you're unlikely to resume repayment for almost a year. At most, 147 months of payments remain before you reach forgiveness, provided you're still carrying a balance.
Let's review the Biden administration's proposed student debt cancellation program. Under the plan announced in August, Pell Grant recipients with federal student loans are eligible for the cancellation of up to $20,000 of their loan balance. Since you have received a Pell Grant and owe more than $20,000 of eligible student loans, you could receive the maximum proposed cancellation benefit. As you know, the income limits to receive the maximum benefit are $125,000 for a single person or married person filing separately, or $250,000 for joint-filing households. You are income-eligible if your AGI is below the stated thresholds for your tax filing status on either your 2020 or 2021 tax return.
If you were married and filing separately in 2020 and 2021, and each of your individual AGIs was more than $125,000 but together amounted to less than $250,000, then it makes sense to amend your prior tax returns to married filing jointly. When it comes to the cancellation benefits, the Education Department only cares about your 2020 or 2021 tax returns. If either one meets the income and filing status requirements of the cancellation benefit, then you're eligible.
The IRS allows you to change your status on tax returns filed within the previous three years by filling out Form 1040-X. Note that while you can change your status from married filing separately to married filing jointly, the opposite is not true.
Now let's consider your new employment contract and bonus. It sounds like you received that in 2022 and will need to complete two years with your employer before you're clear of any obligations to pay some of that back. I think it's a great idea to hold onto that bonus money, maybe in a separate interest-bearing account, until your contract period is complete.
That nicely aligns with pandemic forbearance, which gives you time to see if your new job is a good fit without the pressure of having to make student loan payments or accrue interest on them. Plus, during this time, you might find that the government knocks $20,000 off the balance of your student loans. All are strong financial incentives to sit tight on your student loans while working on other aspects of your overall financial wellness.
Between now and the end of the forbearance extension and your sign-on bonus period, build a budget. Track your major monthly expenses. Make sure you know what that average number is, multiply it by six, and set that as your dedicated emergency fund target. If it's $6,000, then you should have a dedicated emergency fund of $36,000. This is separate from your spending account, forgiveness planning fund and retirement savings. It can have some of your bonus in it, but as you're aware, until you're clear of the conditions of the bonus, you don't want to spend any of it. I would also eliminate less flexible debt like your credit card and auto loan before switching gears on your student loans.
Let's circle back to the plan to amend your filing status for previous tax years. Thankfully, your PAYE payment doesn't change the minute you update a tax filing status. Your PAYE plan has an anniversary date by which you must provide updated income documentation in order for the government to continue calculating your payment based on your income. If you fail to provide the information, your PAYE plan payment will increase to a standard 10-year plan payment. Your current PAYE anniversary date is Aug. 10, 2023. That will likely be pushed back even later with the recently announced forbearance extension. That means your minimum monthly PAYE payment will remain $459 a month once forbearance ends and until you're next due to report your income.
Before that happens, you will have an opportunity to file your 2022 tax return. If you file jointly, your loan payment will reflect your combined taxable incomes, but it doesn't have to include your signing bonus. Since that was a one-time payout, you can say that your current taxable income (in the month you recertify, no earlier than July 2023) is less than your recent tax return, which is inflated by the bonus. Instead, use pay stubs to document your income for PAYE.
If your combined taxable incomes are high enough to result in a monthly payment that's greater than that of a standard 10-year plan (about $1,485 a month), then the most your monthly payment can be is the standard 10-year plan amount. Your taxable income needs to be more than $212,000 per year for a family of three for your monthly PAYE payment to reach $1,485. If that is the case, CONGRATULATIONS! That means a standard 10-year plan payment is less than 10% of your discretionary income. That is a wonderful position to be in.
Community property state twist
There's a twist to consider for you and other residents of community property states, where spouses are joint owners of nearly all assets and debts acquired in marriage. If you normally earn $135,000 of gross income and contribute $20,000 to your 401(k) retirement account, your AGI would be around $115,000. If your spouse earns $25,000 and puts $6,000 into a traditional IRA or 401(k), then your spouse's AGI would be $19,000. Your total household AGI would be $134,000 (excluding your bonus). When filing separately in a community property state, half of that household AGI would be assigned to your tax return ($67,000) and the other half to your spouse's return.
You can use that AGI from your separate tax return when it comes time to recertify your income for PAYE. The VIN Foundation Student Loan Repayment Simulator shows that your resulting payment would be about $458 a month. That is darned close to — and a little less than — your current monthly payment of $479.
The simulator also shows you would reach forgiveness, but even with the potential tax on forgiveness, you're projected to pay less in total than your current remaining balance. That's a tough deal to beat.
All of this is meant to illustrate that you have some special circumstances that will allow you to continue benefiting financially from PAYE, so you can keep and use that bonus and the rest of your family earnings to build your overall wealth.
You also mentioned a possible refinance of federal student loans to a lower-interest loan, which would be a private refinance. I discourage that. Regardless of how the cancellation benefits pan out, you have much more flexibility and much lower repayment risk with your loans in the federal student loan system. And you don't want to have to add your spouse as a co-signer on a private loan just to decrease your flexibility and increase your repayment risk. You might reconsider how that refinance option looks after the pandemic forbearance benefits end and your bonus is no longer at risk.
At least one new income-driven repayment plan is on the horizon, as are favorable capitalization changes, starting July 1. Although the information on that is limited so far, I believe you could have an opportunity to change to a repayment plan that is even better than PAYE.
To sum up, I wouldn't change your loan repayment structure or tax status until:
- pandemic forbearance benefits end;
- your bonus is free of conditions;
- you receive final word on the $20,000 loan cancellation benefit;
- the federal government details the new income-driven repayment plan.
The best news of all is that there is zero financial detriment for you to wait and see.