Med School Loan Interest in Forbearance vs. Roth IRA

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills
Post Reply
Topic Author
JasonS
Posts: 5
Joined: Wed May 04, 2011 8:56 am

Med School Loan Interest in Forbearance vs. Roth IRA

Post by JasonS »

My wife and I are both about to graduate med school and start our residencies this July. We are working on a financial plan/budget and have hit a few snags. We will each have about $240k in loan debt and plan on going into forbearance (subsidized/unsubsidized Staffords at 6.8% make up about 2/3, PLUS loans at 8.5% make up other 1/3). We are also planning on starting our retirement funds via Roth IRAs (our institution does not do a company match for 401k). Since we will have stable employment over the next 4 years, we will be saving for emergencies while concomitantly putting money into our Roths. My questions are as follows:

1. Would it be better to chip away at some of the interest while in forbearance (this would not be tax deductible since in forbearance) or max out each of our Roth IRAs? My inclination would be to max out IRA since there is no tax advantage to chipping away at interest in forbearance.

2. If we can't max out our Roths, would it be wise to place emergency funds into the Roths, subsequently maxing them out, due to the liquid state of a Roth?

I appreciate the advice! Any other tips you can think of are welcome too (new member - still wrapping my head around investing/finance info - finishing Bogleheads Guide to Investing)!
Uninvested
Posts: 657
Joined: Sun Mar 13, 2011 2:21 pm

Post by Uninvested »

Hi guys. Good luck in graduating and your internship. I did this 30 years ago and it was a lot harder then and we never slept. I had debt like you did when inflation adjusted. Here is what I advise as I hated debt. Don't worry about Roth IRAs, investments, etc. Just pay off the debt as quickly as you can. And then never ever borrow anything ever again. I can tell you that the psychic value from that outweighs worrying about stocks when you are in training. Good luck.
dhodson
Posts: 4117
Joined: Mon May 24, 2010 3:03 pm

Post by dhodson »

considering you are currently in a low tax bracket right now and likely never will be again, id avoid the non matching 401k like you are planning. i personally would pay off the debt since its guaranteed savings and the amount you would be putting into a roth over the next 4 years will likely not amount to a significant portion of your retirement compared to the money you will be putting in post residency so it wouldnt seem to me worth the gamble but if u feel strongly about the market over the next few years then either way with a 2 physician income you can play that gamble. those rates just seem to high for me personally to save instead of paying them off. possibly if taxes really rise in 2 years, id re-look at this.
Topic Author
JasonS
Posts: 5
Joined: Wed May 04, 2011 8:56 am

Post by JasonS »

Thanks! Very good advice. Any thoughts on establishing an emergency fund? Or would the money be better spent paying down the debt? We would like to eventually buy a house when out of residency, so we were going to use our emergency fund for a down payment when the time came. Any thoughts?
dhodson
Posts: 4117
Joined: Mon May 24, 2010 3:03 pm

Post by dhodson »

i too am a physician and it gets harder to give good advice on those other questions. a lot depends on what sort of house u will be purchasing and how much u guys think u will make after residency. i recommend buying a smaller home first although the inclination is to get the one house so u dont have to move. that is another topic all to itself. its hard to argue against an emergency fund but as long as u have good health insurance and some life insurance and possibly some disability, it seems unlikely that an emergency would occur where neither of you could work. most families could live off the salary of one physician for sure. disability would seem to be the biggest risk but disability is expensive. a high percentage of docs post residency get disability insurance but during residency it varies (mostly bc of cost). lastly dont get your investment advice from any person who sells you insurance. you will regret it. insurance is a highly polarizing item to discuss but important. unfortunately the insurance field is filled with people who are either unethical or more commonly lack the knowledge to properly sell the products they push on physicians. interestingly on this site there are several good agents (my interpretation from reading their posts).
Topic Author
JasonS
Posts: 5
Joined: Wed May 04, 2011 8:56 am

Post by JasonS »

We will have good health ins as well as life/short and long term disability while in residency. We also have the option to consolidate all of our loans with the fed govt at a rate of 7% and we could start income-based repayment. If we consolidate, we have to start repayment. I'll have to look at what payments would be on that schedule, but it certainly could get us going and that would qualify us for tax deductions on our payments.
Another thought is that my wife is doing a 3 year residency whereas mine is 4. During my last year, while she has a job, we can probably quickly establish an emergency fund/ down payment on a reasonable house with her attending salary.
pochax
Posts: 1374
Joined: Tue Oct 21, 2008 11:40 am

Post by pochax »

what specialties are your residencies in? $480k in high-interest debt is a LOT of debt and unless you are both going to be in high-income fields i think paying down the debt will be the primary goal. you will be hardpressed to beat 7-8% annualized returns (which is what paying down your debt gives you).
dhodson
Posts: 4117
Joined: Mon May 24, 2010 3:03 pm

Post by dhodson »

that will work as long as u make no additional large purchases. i cant tell u how many times ive seen people make big purchases at the end of residency. as i mentioned before, id buy a small house or dare i say rent post residency at first. i will also tell u a lot of docs dont work out with their first job. they just dont always get along like you think they should and its probably double the odds with 2 docs.
relentless
Posts: 448
Joined: Mon Mar 14, 2011 10:05 pm

Post by relentless »

Will you have access to Roth 403b/401k where training? If so, you can put a lot of money in your Roth IRA and Roth 403b in your last year or so of training. Calendar year limit on Roth 403b is 16.5K depending on plan (so in PGY3 you can each put in 33K). Then you can get lots of Roth space and save on interest relative to putting money in Roths PGY1 and PGY2. Catch is you may have to take out additional loans your last year to fund the Roth.

OTOH, you need emergency fund now and setting up Roth IRAs early on can serve both purposes. I do use my Roths as emergency fund. Primarily money market, some short term bond mutual funds. Once my net worth is positive will become more aggressive with investments.

My perspective is in 30 years you will likely miss the Roth space more than the extra interest you are paying. My answers are assuming you are not both going into low paying primary care fields. Based on the length of your residencies I would guess she is primary care and you are neurology?

Other unsolicited advice: read about Dr. North and Dr. South in Millionaire Next Door.
User avatar
Ted Valentine
Posts: 1561
Joined: Tue Jul 10, 2007 10:28 am
Location: Music City USA

Post by Ted Valentine »

I don't understand how allowing interest to accrue at up to 8.5% to invest a measly $10,000 in a Roth is financially savvy. It sounds like you're letting taxes drive the bus on this whole plan. Not only do I not see how that math works out in your favor right now, its also based on a ton of assumptions about the future. I vote just pay the loans aggressively.

Congrats on graduation.
Although our intellect always longs for clarity and certainty, our nature often finds uncertainty fascinating.
Topic Author
JasonS
Posts: 5
Joined: Wed May 04, 2011 8:56 am

Post by JasonS »

So I looked into federal consolidation on the income contingent repayment (ICR) plan. Doing that would get me a 7% rate. If I did auto-debit, it would reduce the rate to 6.75%. Payment would be $585/mo (each) based on PGY1 salary and the payment on interest is tax deductible. I think we're going to do that and then switch to fixed 10yr schedule once we are finished. Any thoughts? Thanks for providing me with a sounding board...it's been great working through this with everyone!
relentless
Posts: 448
Joined: Mon Mar 14, 2011 10:05 pm

Post by relentless »

Ted Valentine wrote:I don't understand how allowing interest to accrue at up to 8.5% to invest a measly $10,000 in a Roth is financially savvy. It sounds like you're letting taxes drive the bus on this whole plan. Not only do I not see how that math works out in your favor right now, its also based on a ton of assumptions about the future. I vote just pay the loans aggressively.

Congrats on graduation.
They do need an emergency fund of probably at least 10K and I think most on this board would agree this should be done before paying down debt. And hopefully we can agree that Roth is not a bad place to park an emergency fund since contributions can be removed at any time.

Yes I am making assumptions but (I would contend) not unreasonable ones about additional contributions to Roth beyond emergency:

First of all their weighted average interest rate is 7.367%.

I am assuming they are high income physicians and are disciplined enough to pay off extra borrowing within a year (and specified that this is not a good strategy if they are not highly compensated physicians). The math assuming one dollar invested at real 6% return for 30 years is $5.74 and for 40 years is $10.30. A more conservative real 3% return for 30 years is $2.42 and for 40 years is $3.26 in 2011 dollars (or actually 2014 dollars if they do this in 3 years). Even a tiny 1% real return over 40 years is $1.49 and still comes out ahead.

Assuming inflation of 3%, their real interest expense per dollar if paid one year after Roth investment in last year of training is real (1+0.07367-0.03)-1= 4.4 cents. I would gladly pay $440 real interest on 10K (or $740 nominal) now for the potential to have tax free growth to 103K real (or 335,990 nominal) dollars in 40 years assuming 6% real return and 3% inflation).

That is NOT chump change.

I do agree that they have a lot of debt especially if primary care physicians and have to address this.
Erwin007
Posts: 431
Joined: Tue Aug 19, 2008 8:29 am
Location: Intermountain West

Post by Erwin007 »

The other thing to consider in all of this is the need for disability and term life insurance. I know that you said you have that through your program, but that's just for during your residency, and in most places is pretty lousy.

In my opinion, you'd be better off to get disability insurance now, with the ability to increase the payouts in the future after you graduate from residency. You can do that without having to go through the underwriting process again, so if you're both healthy now it's a good way to go. This will protect your future earnings.

There are lots of good tips and reading in the Wiki on issues such as these as it relates to physicians. You can spend a lot of time reading them (which you'll have in spades thanks to the ACGME's new work hour restrictions).

For what it's worth, my wife (a retired dental hygienist and now homemaker to our family of 5) and I max out our Roth IRAs and I contribute to my institution's max on the 401k (3.5% of income). When residency is over ?(5 years), we will have contributed close to $50K to our Roth IRAs and have nearly $15K in my 401k. We have of course done this at the expense of accruing interest (which was in deferment the first 2 years of my residency) on my $190K of loans (half of which is at about 3% interest, and the other half of which is at the 6.8% interest). In my mind, I know that I'll make enough in the future to easily pay off my loans, but won't have the ability to make up for years of lost investing.
relentless
Posts: 448
Joined: Mon Mar 14, 2011 10:05 pm

Post by relentless »

I meant highly compensated when you are an attending.

The advantage of the Roth for trainees (I am in the same boat) is that you are NOT highly compensated now and are in the lowest bracket that you are ever likely to be in (at least until retirement). I am not sure how well neurologists do overall but family medicine may be an uphill climb with that debt load, especially if she wants to go part time with future kids, etc.
campy2010
Posts: 1035
Joined: Sun Nov 28, 2010 5:01 pm

Post by campy2010 »

This wasn't part of your original question, but if I were in your situation I would price out repayments on the Income Based Repayment plan and cross your fingers that the public service forgiveness plan is not canceled before you work 10 years in a hospital. There is some concern that this program will be canceled before anyone can take advantage so the sooner you start repaying the faster you get to discharge. Unless you live in a high cost area, resident salary is high enough to move from forbearance to repayment, IMHO.

As others have stated, I would not worry about the Roth at this point.
Topic Author
JasonS
Posts: 5
Joined: Wed May 04, 2011 8:56 am

Post by JasonS »

Here's some more food for thought.

The ICR payment of about $585/mo does not cover all of the interest. Basically this payment helps chip away at it and it reduces the rate to 6.75% for all of them across the board. With the average rate calculated by relentless as 7.367, this is a reduction of 0.617%, without paying the full interest every month.

That amount of money could definitely be used to max out Roth IRA and then some.

I know we'll be able to pay off the loans with our salaries post-residency. We had planned on forbearance and then going into a 10yr fixed schedule.
campy2010
Posts: 1035
Joined: Sun Nov 28, 2010 5:01 pm

Post by campy2010 »

JasonS wrote:So I looked into federal consolidation on the income contingent repayment (ICR) plan. Doing that would get me a 7% rate. If I did auto-debit, it would reduce the rate to 6.75%. Payment would be $585/mo (each) based on PGY1 salary and the payment on interest is tax deductible. I think we're going to do that and then switch to fixed 10yr schedule once we are finished. Any thoughts? Thanks for providing me with a sounding board...it's been great working through this with everyone!
Repaying with the Income-Based Repayment program is a good plan but I would suggest that you don't consolidate your loans. If you consolidate then you can't repay the higher interest loan faster than the others. At some point you may want to lump sum payments into the 8.5% loan. Once you consolidate this is no longer an option. Without consolidating, you are still repaying 7% on average, but you retain the flexibility of being able to repay your loans separately.
RabbMD
Posts: 330
Joined: Thu Feb 05, 2009 9:51 pm

Post by RabbMD »

I advised my sister in law who is graduating to start an ob residency in July this year the following...

At least pay the interest on your student loans. Currently in residency your income is low enough to deduct the interest paid. This ability is AGI based. After you graduate you will no longer be able to deduct this interest. That makes your interest rate effectively paid lower in residency than it will be later. As long as you have no other IRAs under current law you do not lose the ability to ever contribute to a ROTH later with higher incomes. You and your wife can both backdoor convert to roth IRAs every year after residency as cash flow improves.
campy2010
Posts: 1035
Joined: Sun Nov 28, 2010 5:01 pm

Post by campy2010 »

One more thing. There are two reasons why IBR is probably better than ICR.

1. "the IBR program also includes a limited subsidized interest benefit. If your payments don't cover the interest that accrues, the government pays or waives the unpaid interest (the difference between your monthly payment and the interest that accrued) on subsidized Stafford loans for the first three years of income-based repayment. Interest on unsubsidized loans and interest that accrues on subsidized Stafford loans after the first three years will be capitalized upon status changes (e.g., a borrower is no longer eligible for IBR or chooses to switch to a different repayment plan)."

2. "Overall, income-based repayment is probably a bit better for borrowers than income-contingent repayment, especially if the borrower's financial circumstances improve. Income-contigent repayment caps monthly payments at 20% of the difference between AGI and 100% of the federal poverty line. Income-based repayment is clearly more generous than this aspect of income-contingent repayment, since it assesses a lower percentage, 15%, of a smaller definition of discretionary income, the excess of income over 150% of the poverty line."

http://www.finaid.org/loans/ibr.phtml
User avatar
Hector
Posts: 1524
Joined: Fri Dec 24, 2010 2:21 pm
Contact:

Post by Hector »

dhodson wrote:dare i say rent post residency at first.
seems like doctors take a lot of pride in owning a home then.
User avatar
Hector
Posts: 1524
Joined: Fri Dec 24, 2010 2:21 pm
Contact:

Post by Hector »

Ted Valentine wrote:I don't understand how allowing interest to accrue at up to 8.5% to invest a measly $10,000 in a Roth is financially savvy. It sounds like you're letting taxes drive the bus on this whole plan. Not only do I not see how that math works out in your favor right now, its also based on a ton of assumptions about the future. I vote just pay the loans aggressively.

Congrats on graduation.
A person with huge debt often does that. Mostly the case with doctors. They are tired of living frugal in the school and during residency.

Once they started getting fat paychecks, they want everything. A big retirement account. Expensive car. Expensive house. All that money can buy. Loan is so huge that it gonna take forever to do one thing after another and they choose to do all to start with.
relentless
Posts: 448
Joined: Mon Mar 14, 2011 10:05 pm

Post by relentless »

RabbMD wrote:I advised my sister in law who is graduating to start an ob residency in July this year the following...

At least pay the interest on your student loans. Currently in residency your income is low enough to deduct the interest paid. This ability is AGI based. After you graduate you will no longer be able to deduct this interest. That makes your interest rate effectively paid lower in residency than it will be later. As long as you have no other IRAs under current law you do not lose the ability to ever contribute to a ROTH later with higher incomes. You and your wife can both backdoor convert to roth IRAs every year after residency as cash flow improves.
Can't disagree with that, although it depends on the situation. Paying off interest and getting deduction has not made sense for me given my low tax bracket and low interest loans but might for OP and your sister in law.

I think there is an opportunity cost in passing up the Roths as you go that should not be underestimated. Later the amount you can contribute as percentage of your salary (and percentage of overall investments) will likely be very small and the backdoor Roth could disappear. Where are you going to put bonds when you are in your 50s/60s/70s/80s when you don't have much Roth space? In either taxable or tax deferred--both of which are much less preferable than Roths for retiring physicians.

However, I agree that may not be right thing for OP given high debt with high interest rate. Perhaps OP should limit Roths to emergency fund.
SammyD1st
Posts: 16
Joined: Sat Aug 16, 2008 7:46 am

Post by SammyD1st »

My wife and I are in a similar situation, a few years ahead: she is finishing residency this year, while I'm a lawyer with almost as much in student loans.

You two are EXCELLENT candidates for the "Public Service Loan Forgiveness" program: http://www.finaid.org/loans/publicservice.phtml

Reason: your 3/4 years of residency very likely qualify as "public service" because most teaching hospitals are non-profits/government.

Therefore, go ahead with the consolidation and ICR, and start making payments as soon as you start residency.

Also, if you do a Fellowship those 1-2 years will also very likely count towards the 10 years for the Public Service Loan Forgiveness.

Thus, if you can continue to be employed at a job that qualifies for the Public Service Loan Forgiveness after residency/fellowship (i.e. attending at a non-profit, but NOT your own practice) then you only have 4-5 more years until total loan forgiveness.

I think it would be VERY difficult for you to beat this approach by earning more money post-residency, due to progressive taxation.

So, make the ~$500 ICR payments, and then (in my opinion):
1. save up an emergency fund in a SAVINGS account - the tax savings by using a Roth for your emergency fund are trivial. A $10,000 emergency fund should be sufficient.
2. DON'T buy a house until you have a >20% down payment. Buying a house is NOT an accomplishment in life, it's just a place to live.

Also, GL Advisor is a leading company that advises young professionals on students loans. Their fees are very reasonable, and the advice is worth every penny in my opinion. (Not affiliated.)

Good luck.

- Sam
relentless
Posts: 448
Joined: Mon Mar 14, 2011 10:05 pm

Post by relentless »

Sammy--Definitely looks like could be a good program for them to consider. OP should look at the numbers and details before commiting to this plan, though.

If you are considering going to work in an academic institution, check out the AAMC Report on Medical School Faculty Salaries to get an idea of what ballpark salary to expect and to compare to private sector numbers. Your med school library should have a copy.

If you are going to do the plan Sammy suggests, I would be back to recommending more rather than less Roth contributions. The potential benefits are not "trivial" as the tax savings alone over a lifetime could easily be higher than the original contribution (in today's dollar terms not future inflated dollars). I am not sure if Sammy fully comprehends the power of compounding over a very long period of time or the fact that you are taxed on nominal gains and the Roth shelters you from this. The only thing "trivial" is the current interest you get in your savings account.
User avatar
CMartel2
Posts: 225
Joined: Fri Feb 20, 2009 10:46 pm

Post by CMartel2 »

In my opinion, you all should consider the Income Based Repayment program, at least for the Stafford loans. The federal government will pay off any unpaid interest on the subsidized portions of your loans.

Anything you can do to tread water at this point seems like a wise idea to me at this point. It's not so

There are other ways of getting some form of loan repayment. I'm personally going to practice in a rural area, where you can get both federal, state, and private loan repayment. That will completely vaporize my student loans. I don't think it will quite do it with 240k each, though.

Residency is tough. It's nice that you have two incomes between the two of you during this. I've got a 3-kids and a wife I'm supporting on mine. Moonlighting, her I come! :)
jmbkb4
Posts: 280
Joined: Sat Feb 12, 2011 4:47 pm

Post by jmbkb4 »

Uninvested wrote:Hi guys. Good luck in graduating and your internship. I did this 30 years ago and it was a lot harder then and we never slept. I had debt like you did when inflation adjusted. Here is what I advise as I hated debt. Don't worry about Roth IRAs, investments, etc. Just pay off the debt as quickly as you can. And then never ever borrow anything ever again. I can tell you that the psychic value from that outweighs worrying about stocks when you are in training. Good luck.
I think this is horrible advice.

Definitely both max out your Roth IRAs. You'll be able to do it for your residency and fellowship but NOT after that. Your $$$ can grow tax-free, including interest.

Then you can pay down your loans if you want to in residency.

But don't forget to have a little fun too.

MAX OUT YOUR ROTH IRAS WHILE YOU CAN!!!
Dirty Jacket
Posts: 28
Joined: Thu Mar 31, 2011 9:31 pm

Post by Dirty Jacket »

This topic makes my tummy hurt :oops: Just graduated med school myself, my wife is in grad school with no income, we are renting in a big city, so money will be tight...oh, and there's the $190K in loans (majority at 6.8% / ~18K at 8.5% / 5K @ 9.7%) to start paying back in a few months.

Not sure how we're going to handle this right now, I think we may have to defer until she graduates in August 2012 and is making ~$75K+ (hopefully). At that point, our plan is to utilize my salary for maxing out tax efficient retirement accts and paying off my loans as aggressively as possible. After all, we'll survive a year of living off of my $48K, we'll be in heaven at 75K (this is assuming, of course, that she gets a job. $75K salary is in the bottom 10% of her field, so we are hoping for more).

Hopefully it works out. I am going into a very high paying (...for now) surgical sub-speciality, so there is light.
Post Reply