It makes sense to a lot of people in residency to defer their student loan payments until they start earning a larger income. Practically speaking, deferment sounds like the ideal option because you're earning a pretty small salary - especially when compared to the size of many student loan debts - and you understandably want to take home as much cash as possible from each check.
But don't make that decision just yet. More cash in hand might sound good in the short term, but consider the sacrifice you'll be making over the long-term. Remember, residency and fellowships are only a brief part of your medical career. If you decide now to play the long game when it comes to paying back student loans, you'd be wise to start making those payments now.
Student Loan interest is deductible
First, you’re essentially making interest-only payments during residency and student loan interest is deductible for people with a MAGI (Modified Adjusted Gross Income) of $207,140 or lower. But, it completely phases out when income exceeds $247,140, which means you probably won’t receive this deduction if you wait to pay your student loans back later because your income will be too high. Starting repayment during residency allows you to benefit from a deduction during the lower income years rather than missing out on it altogether.
As with any IRS ruling, a few rules do come into play here. You can claim the deduction if all of the following apply:
You paid interest on a qualified student loan in tax year 2017;
You're legally obligated to pay interest on a qualified student loan;
Your filing status isn't married filing separately;
Your MAGI is less than a specified amount which is set annually; and
You or your spouse, if filing jointly, can't be claimed as dependents on someone else's return.
A qualified student loan is a loan you took out solely to pay qualified higher education expenses that were:
For you, your spouse, or a person who was your dependent when you took out the loan;
For education provided during an academic period for an eligible student; and
Paid or incurred within a reasonable period of time before or after you took out the loan.
One factor in that list can be problematic for some residents.
If your filing status is not "Married filing separately"
Many of you are rightly filing separately to keep your income down because the required payment of the eligible repayment options for federal loan forgiveness will calculate your payment based on the income listed on your tax return. This makes sense if you have a spouse that is working and bringing in significant income. This doesn’t make sense if your spouse is not working as there are tax benefits to filing jointly and you lose the student loan interest deduction. The logic in filing separately is to keep the income as low as possible so the required repayment is as low as possible, which leaves a much larger debt to be forgiven and less out of your pocket over time. You don’t want to file jointly just to take advantage of the student loan interest deduction and other tax benefits if it means you’ll offset all of the tax avoided by increasing your required student loan payment. You’ll need to look at the math to see which plays out more favorably for you. Here’s what you need to consider:
- What is the required student loan payment if I file separately? Ex. (Annual) $3,600
- What is the required payment if I file jointly? Ex. (Annual) $7,200
- What is the tax savings if filing jointly instead of separately? Ex. (Annual) $1,000
- If filing jointly, what amount of interest would be deductible? Ex. (Annual) $2,500 (12% rate) tax savings $300.
$7,200 -$1,000 - $300 = total outlay of $5,900 if filing jointly (receiving tax savings from student loan interest deduction, tax benefits, but paying a higher student loan payment).
If you file separately, your payment is only $3,600, so in this example, filing separately is worth foregoing the student loan interest deduction and tax benefits of filing jointly.
Most of you will end up working for an eligible 501(c)3.
Sometimes we see physicians deferring repayment because they believe they have a private practice gig set up, or they intend to work for a large hospital that wouldn’t qualify for student loan forgiveness.
You may be surprised.
It’s not just teaching hospitals that qualify. According to the American Hospital Association (AHA), in 2014 about 78 percent of the 4,974 US community hospitals were nonprofit entities (58 percent private nonprofit and 20 percent operated by state or local governments). The remaining 22 percent are for-profit, investor-owned institutions. If 78% are eligible for Public Service Loan Forgiveness, I would make the small payment required during residency just in case. Having 48 qualifying payments under your belt with only 72 to go and based on a fifth of the income you’ll eventually make, could save you a significant amount of money. Plus, in the end, if you do end up in a private practice, then you helped yourself out by servicing part of the interest during residency. In that situation, you’re paying the loans back in their entirety over your lifetime, so paying the interest during residency didn’t hurt anything.
You can make qualifying payments through an eligible repayment plan without making any payments during your first year of residency.
At the very least, you should begin an eligible repayment plan immediately after medical school for the following year. The required payment is determined by the income listed on your most recent tax return and for most physicians, the income listed is zero during their intern year because they weren't earning an income. If the most recent tax return shows a very low income or no income at all, the monthly payment will be zero. Though the monthly payment is zero each month, you are technically in repayment through an eligible repayment plan; therefore, these are qualifying payments that count toward the 120 payments needed for Public Service Loan Forgiveness. During the year immediately following medical school, whether you defer or repay, there's not an out-of-pocket expense, so why not elect to begin repayment and build a few qualifying payments just in case.
All this to say, I can’t think of a good reason to defer payments. When the cost is the loss of a $2,500 tax deduction each year and failing to maximize what could be forgiven by the federal government, it doesn’t make sense. The only reason to do so would be if the extra cash flow is necessary to float your financial situation.
If you assumed a resident was making $55,000 (married filing jointly without an income earning spouse), and had $150,000 in student loans at a 6.8% interest rate, the IBR for New Borrowers or the PAYE repayment plan would require a payment of $145 per month.
Putting $145 back in my pocket each month at the expense of what we just discussed seems hardly worth it to me.