The core benefit of Public Service Loan Forgiveness (PSLF) – tax-free forgiveness after 120 qualifying payments with a qualifying employer – is well and widely known.
Because of the tax-free forgiveness, PSLF borrowers are incentivized to maximize the amount of their forgiveness by minimizing the dollar amount of their qualifying monthly payments. In other words, because PSLF is tax-free, the borrower is not penalized by a loan balance that grows each month.1
One of the ways a borrower can lower their monthly payment is reducing their adjusted gross income (AGI) by making contributions to their retirement plan.2
Enrollment in PSLF includes the borrower being in one of the income-driven repayment plans (IBR). These IBR plans calculate monthly payments based the borrower’s “discretionary income,” which is calculated with the borrower’s AGI.
Bradley Yanke, Marquette 2011, is an attorney with Anderson O’Brienin Stevens Point, where he practices in accident and personal injury, litigation and dispute resolution, and worker’s compensation.
Among other strategies, a borrower can reduce their AGI, and therefore their monthly loan payment, by making contributions to their retirement account, which for a PSLF borrower is likely a 401(k), 403(b), or 457 account.
For 2021, employees can contribute up to $19,500 to a 401(k), 403(b), or 457 account. The more a borrower contributes, the more their AGI goes down and the more their monthly PSLF qualifying payment goes down.
In this sense, PSLF’s tax-free forgiveness means that retirement contributions can provide a triple benefit for borrowers.
First and albeit obvious, it is beneficial to save, and save early, for retirement.
Second, retirement contributions that reduce your AGI can reduce your taxable income.
Third, reducing your AGI reduces your monthly PSLF payments.
Therefore, in addition to the shorter payment term, PSLF’s tax-free forgiveness provides an opportunity for borrowers to put their retirement contributions to work for them in more ways than one.
This is part of a series of tips the Public Interest Law Section has been doing on Public Service Loan Forgiveness. If you would like more information on Public Service Loan Forgiveness, see the following blog posts:
This article was originally published on the State Bar of Wisconsin’s Public Interest Law Section Blog. Visit the State Bar sections or the Public Interest Law Section web pages to learn more about the benefits of section membership.
Endnotes
1 Disclaimer – This is not tax, legal, or investment advice. Every situation and borrower is different, and borrowers should consult with their tax, legal, and financial professionals before making any decisions.
2 This assumes pre-tax (or non-Roth) contributions.
