Contributions to your retirement account lower your taxes and encourage you to save for your golden years.
Imagine if these contributions also helped pay off student loans. You might decide to contribute more.
New rules reward retirement account contributions. The details are essential, so make sure to understand them well.
The Saving on a Valuable Education (SAVE) plan offers lower monthly payments, less interest, and principal forgiveness beginning after ten years.
There is a hidden loophole. Contributions to your retirement account lower payments, reduce interest and increase the debt forgiven by the government.
Retirement Savings Lower Loan Payments
The SAVE plan lowers student loan payments with retirement contributions: 5% for undergraduate debt and 10% for graduate debt.
The SAVE plan bases minimum monthly payments on a percentage of your discretionary income, not the amount borrowed.
- Discretionary income is your adjusted gross income (AGI) minus 225% of the federal poverty line for your family size.
- Households with two earners benefit less.
- AGI is your total income minus eligible adjustments.
Therefore, reducing your total income or increasing your eligible adjustments lowers your student loan payments for the year.
Reduce Total Income
Pretax payroll contributions reduce your total income, leading to lower monthly student loan payments under the SAVE plan. Employers report your net wages, tips, and other compensation on line 1 of Form W-2 and elective deferrals in box 12.
Eligible pretax contributions include 401(k), 403(b), 457, and Thrift Savings plans. The yearly limit is $23,000 per employee, and the limits increase with inflation each year.
Employees making the maximum annual pretax contribution to one of these accounts will lower their loan payments by the following amounts for one year:
- Undergraduate at 5%: $1,150
- Graduate at 10%: $2,300
Increase Eligible Adjustments
Eligible adjustments subtracted from your total income reduce your AGI, leading to lower monthly student loan payments under the SAVE plan. These adjustments are separate from pretax payroll deductions.
IRS Schedule 1 lists twenty-four possible entries. Relevant adjustments include contributions to Self-employed SIMPLE, Self-employed SEP IRA, Section 501(c)(18)(D) pension plans, and Individual Retirement Accounts (IRA).
These adjustments also have annual contribution limits that adjust for inflation over time. This chart shows the yearly reduction in monthly payments corresponding to the maximum contribution for each option:
| Retirement Account Option | Maximum Annual Contribution | Annual Reduction in Undergraduate Loan Payment (5%) | Yearly Reduction in Graduate Loan Payment (10%) |
|---|---|---|---|
| Self-employed SIMPLE | $16,000 | $800 | $1,600 |
| Self-employed SEP IRA | $69,000 | $3,450 | $6,900 |
| Section 501(c)(18)(D) | $7,000 | $350 | $700 |
| Individual Retirement Account | $7,000 | $350 | $700 |
Retirement Savings Boost Loan Forgiveness
Under the SAVE plan rules, retirement contributions can increase student loan interest and principal forgiveness. Since interest compounds daily, the government cancels more debt than the lower monthly payments alone would suggest.
You do not have to repay college grants. The SAVE plan allows specific borrowers to lower their monthly payments to zero, turning an income-driven repayment program into a grant. Why not take advantage?
Principal Forgiveness
The SAVE plan promises unlimited forgiveness of student loan principal after a specific number of full payments based on discretionary income, not the amount borrowed.
By contributing to retirement accounts, the government receives less of your money along the way. The Department of Education publishes the following schedule:
| Years of Full Payment | Undergraduate Debt Forgiven | Graduate Debt Forgiven |
| 10 | $12,000 | $12,000 |
| 19 | $20,000 | $20,000 |
| 20 | $21,000 + | $21,000 |
| 24 | $25,000 | |
| 25 | $26,000 + |
Interest Forgiveness
Retirement account contributions lead to greater student loan interest forgiveness, as the government covers any accrued interest that your reduced monthly payment does not cover.
Since student loan interest compounds daily, we can estimate the time value of these reduced payments. Suppose the interest rate is 5.5%, and you make the maximum annual contribution to your chosen retirement account.
The daily compounding column in this chart shows the additional amount the government might forgive based on your consistent contributions over time.
| Retirement Account Option | Annual Reduction Undergraduate Loan Payment (5%) | Daily Compounding @5.5% Over 20 Years | Annual Reduction Graduate Loan Payment (10%) | Daily Compounding @5.5% Over 25 Years |
|---|---|---|---|---|
| 401(k), 403(b), 457, and Thrift Savings | $1,150 | $41,536 | $2,300 | $123,129 |
| Self-employed SIMPLE | $800 | $28,856 | $1,600 | $85,739 |
| Self-employed SEP IRA | $3,450 | $125,481 | $6,900 | $370,676 |
| Section 501(c)(18)(D) | $350 | $12,679 | $700 | $37,389 |
| Individual Retirement Account | $350 | $12,679 | $700 | $37,389 |
Borrowers enrolled in the SAVE plan achieve total forgiveness for student loans of any size after twenty or twenty-five years of full monthly payments based on their discretionary income, not the amount borrowed.
Increasing your retirement contributions can lower monthly payments and earn more loan forgiveness. Use the Department of Education rules to your advantage and keep more of your money instead of giving it to the government.
