- Even if you have significant debt, you can create a sound financial plan moving forward. Assessing your current reality in detail is the first step, no matter your circumstance.
Each of us is faced with competing financial priorities throughout life. Those of us who financed our education with student loans have one additional factor to consider as we plan our futures.
As of June 2020, the total outstanding student loan debt in the United States stood at $1.67 trillion. According to the National Center for Education Statistics, the average cumulative education debt after law school was $148,800 for the class of 2015–2016. You are not alone if you feel overwhelmed!
Many young lawyers are having trouble making ends meet and are unable to satisfy student loan obligations—for now, anyway. Their focus is on identifying affordable repayment options. Others have discretionary income available after satisfying all monthly obligations (including student loan payments). The issue that they face is how to most prudently allocate excess resources.
Assessing current reality in detail is the first step no matter your circumstance. A sound starting point is to list all your debts, including student loans, car loans, credit cards, and any other type of personal debt. For each, list the loan balance, interest rate, and minimum monthly payment. With respect to student loans, be sure to clarify whether you have a private loan or a federal student loan. Protections associated with federal loan programs may not be available for private loans, as pointed out below.
Let’s start by outlining a few options for those having difficulty making student loan payments.
Student loan consultant Jan Miller revealed that a significant number of attorneys have found themselves with upside-down debt-to-income ratios. For some, the student loan debt exceeds their annual income—sometimes by as much as two or three times.
Miller emphasizes the importance of analyzing the effects of different repayment options on lifetime costs and recommends a holistic strategy, taking into account not only “the numbers” but also life circumstances such as income growth potential, career trajectory, and family situation, considering both the short and long term.
Many attorneys making payments pursuant to the 10-year Standard Repayment Plan (10 to 30 years for consolidation loans) feel financially strapped. Fortunately, options are available that will not only provide immediate relief but also free up funds to pursue other financial goals.
By executive order, President Joe Biden put the following relief measures into place with respect to student loans held by the US Education Department: Loan payments are suspended, collection efforts are stopped, and interest is waived. While this short-term solution, which is effective through September 30, 2021, provides breathing room, it is the long-term issue that needs to be addressed.
Those with multiple student loans may wish to explore whether applying for a Direct Consolidation Loan would result in lower payments. Because the application process is free, why not give it a try if you have more than one outstanding student loan?
With private loans, it can make sense to refinance if a lower interest rate or more favorable terms are available. Consult with a private lender to determine your eligibility.
While not favorable, the following remedies may be the only viable alternatives.
By the way, surveys show that a significant number of student loan borrowers live with anxiety and depression. Self-assessments are readily available that can help determine whether it would be useful to consult with a professional or take advantage of other well-being resources now accessible online. Check out The Legal Burnout Solution.
Attorneys who are easily able to make their monthly payments must analyze the most advantageous allocation of their “excess income.”
While making minimum payments on federal student loans is obvious, in most cases there doesn’t need to be a big rush to pay off the principal. They normally carry a low, fixed interest rate and also have flexible options as described in the previous section.
Keep in mind that up to $2,500 in interest payments made on student loan debt may be tax-deductible, depending on the taxpayer’s modified adjusted gross income (MAGI). An individual with MAGI in excess of $80,000 is ineligible for the deduction.
As an aside, another factor to take into account when determining which loan to pay first is whether someone has graciously cosigned for you. It would be a nice gesture to pay off that loan first because the cosigner’s future borrowing power is reduced until the cosigned loan is satisfied.
Young attorneys who start contributing to a retirement plan today will have a significantly more secure and comfortable retirement than those who wait until age 60 to begin this process. If your employer has established a 401(k) plan and matches employee contributions, contribute enough to collect your full employer match. Note that elective salary contributions are limited to $19,500 per year in 2020, which allows you to add more to your nest egg if your budget permits.
Solo practitioners and partners in small firms wishing to maximize involvement in tax-deferred plans are encouraged to explore the features of the Simplified Employee Pension Plan (SEP) IRA and the Savings Incentive Match Plan for Employees (SIMPLE) IRA. At the very least, establish an IRA. For 2020, the maximum annual IRA contribution is $6,000, or $7,000 once you reach age 50. Squeezing even this amount out of your budget will yield huge long-term results, as illustrated by the following example:
Illustration of the Power of Tax-Deferred Growth
Becky is 29 years old and is able to satisfy her monthly obligations (including student loan payments). She manages to squeeze $500 out of her budget each month, which she contributes to a traditional IRA. When she reaches age 50, she begins contributing $7,000 on an annual basis. Presuming a 7 percent rate of return and an effective tax rate of 25 percent, Becky will have accumulated a retirement nest egg of $982,912 when she reaches age 65, in addition to other investments or properties in her portfolio.
Owning your own home carries with it many benefits, which is why we are willing to assume the accompanying responsibilities. Because real estate generally appreciates in value, it can prove to be a sound investment, allowing you to build equity. At the same time, you have the emotional satisfaction of homeownership and the monthly payments may be less expensive than a rental, depending on the circumstance.
A down payment of at least 20 percent of the purchase price is advisable for conventional loans because this allows you to avoid the expense of private mortgage insurance (PMI). According to Genworth Mortgage Insurance, the average cost of private PMI ranges from 0.55 to 2.25 percent of the original loan amount annually. If you are drawn to a Federal Housing Administration (FHA) loan because it requires only a 3.5 percent down payment, be sure to consider the overall cost of the loan before signing on the dotted line.
Once the decision is made as to the amount that you need to save, commit to placing the amount you will allocate each month into a separate savings account. Arranging for an automatic direct deposit will help you avoid the temptation to spend instead of save.
There is no time like the present to start saving for your children’s future education. Two tax-qualified options to consider are 529 Plans and the Coverdell Education Savings Account. Check out Internal Revenue Service Publication 970 if this topic is relevant to your current situation.
Long ago, I was taught that “what gets measured gets managed.” From my vantage point, this means thoroughly researching all options, having a written financial plan, reviewing progress on a monthly basis, and tweaking the plan as circumstances change. Why wait? Start today.
The 2021 ABA YLD Law School Student Loan Debt Survey Report examines the issues at the heart of the student loan crisis and offers recommendations. Read the report.
This is an edited and abridged version of an article that originally appeared in the March/April 2021 issue of GPSolo magazine, volume 38, number 2, published by the American Bar Association Solo, Small Firm and General Practice Division. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or downloaded or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. Membership in the Solo, Small Firm and General Practice Division is now complimentary. Join now.