I’ve gotten a ton of clients asking me about the Trump administration’s plans in regards to the Public Service Loan Forgiveness program (PSLF). For those who don’t know, PSLF allows you to work for a not for profit employer for 10 years and receive tax-free loan forgiveness. For many borrowers burdened by huge amounts of student debt, PSLF is their only hope. Here’s how you should prepare your finances if you’re worried about Trump repealing PSLF.
Act Like Trump Repealing PSLF is Not Going to Happen
I had an interesting conversation with a client a couple days ago about their $200,000+ student debt balance. She had the ability to refinance and was incredibly worried about Trump repealing PSLF. Hence, her thought was why not go ahead and lock in a lower interest rate and pay everything off. Otherwise she would have to take her chances with whatever the new administration will do over the next 10 years.
If she stays on PSLF and files her certification paperwork, she’s on track to save about $200,000. If she refinances and avoids waiting around 10 years to find out PSLF doesn’t exist anymore, she could save about $50,000.
Let’s think about this scenario like I would as a former bond trader. One outcome gives you savings of $200,000. The other outcome gives you savings of $50,000. The two options are mutually exclusive, meaning PSLF can’t exist and not exist at the same time. Therefore, if I wanted to decide what to do, I would multiple each of the numbers by the probability of each event and sum them.
What is the PSLF Repeal Probability?
This is a hard question to answer without freaking anyone out, because PSLF is almost certainly going to be repealed. However, the major question is HOW. The 2015 Republican repeal plan grandfathered in anyone who currently holds federal student debt. It does not apply to anyone seeking new debt.
The Democrats also effectively proposed their own repeal plan in President Obama’s budget around the same time. The President tried to limit PSLF to $57,500 in max benefits. The Democrats’ PSLF repeal plan was actually far more damaging than the Republicans for current borrowers.
Fast forward to January 2017, and Republicans have all the levers of power. Therefore, my expectation is that Trump repealing PSLF will happen within 12-18 months, especially given how the confirmation hearing for his Education Secretary hardly mentioned student loan policy. However, current borrowers are very likely going to be grandfathered in when the repeal happens. I’d put the odds at about 85% that this will happen, with odds of 15% that current borrowers will be completely screwed over. I’ll say though that these probabilities are my educated guess and take them with a grain of salt.
Now Calculate the Expected Value of Staying on PSLF
Going back to the earlier example, say you have $200,000 of savings under PSLF or $50,000 in losses if you stay and it gets repealed. With my probabilities, the expected value of staying on PSLF is $200,000*0.85+(-$50,000)*0.15=$162,500. Even if the probability is 50/50, the expected value of staying on PSLF is still very positive.
Therefore, if you’re looking at PSLF logically as an investment professional would, you need to be staying on the program if your savings are significant.
Now Prepare Your Finances Like Trump Repealing PSLF is Happening Tomorrow
So what about my guess that there’s a 15% chance that Trump repealing PSLF becomes reality? If I told you that there was a 15% chance of something horrible happening, you wouldn’t feel so good. That’s why you need to prepare your finances just in case the worst becomes reality. After all, many election models had Trump’s chances at below 5%.
Borrowers going for PSLF fall into two camps. The first group could pay their student debt off if they wanted to. They’re pursuing PSLF because it’s a better financial decision, not because it’s their only option. The second group can never repay their student debt. They will be forced onto private sector loan forgiveness in the absence of PSLF.
Borrowers in the first group will have debt to income ratios below 2. They will refinance their loans with a lender like the ones in my sidebar above. Then, they’ll get the lowest interest rate they can and pay it back.
Borrowers in the second group will need to save a lot of money. For repayment plans like IBR, an individual with a $400,000 student debt balance might have a balance of $600,000 after 25 years of not covering the full interest payments. That borrower would then owe taxes on the $600,000 forgiven balance as if it was income. The only way to pay that burden is to save $500-$1,000 a month in an investment account at a place like Vanguard. When the tax bomb hits, you withdraw the full amount, pay taxes on your capital gains, and pay off the tax debt.
Set Yourself Up For Success Regardless of What Happens with PSLF
Trump repealing PSLF would be bad news for a large number of borrowers. That said, it doesn’t have to be a disaster. Plan for PSLF with your loan repayment strategy. Fill out the PSLF certification form. Maybe consider submitting it every 6 months instead of every year.
If you stop building progress towards tax free loan forgiveness, you’re giving up the potential future savings that could very well happen. We’re all probably going to be dealing with higher tax rates in the future anyway, so you might as well get all the benefits you’re eligible for.
Hedge your risk against PSLF repeal. Save aggressively outside of your retirement plan. If Trump destroys PSLF, then you can retool your loan strategy accordingly.