Tax-Free Student Loan Repayment: $5,250 Cap and 401(k) Match

An employer can pay up to $5,250 per year toward an employee’s student loans on a tax-free basis under Internal Revenue Code Section 127. That means tax-free student loan repayment by an employer escapes federal income tax withholding, Social Security tax, and Medicare tax for the employee, while the employer still deducts the payment as an ordinary business expense.¹² The benefit is permanent, and the $5,250 cap will adjust for inflation starting with the 2026 tax year, though the IRS has not yet published an adjusted figure.

The $5,250 Annual Cap

$5,250 is the total amount of tax-free educational assistance an employee can receive from one employer in a calendar year.¹ It is a combined limit across every benefit offered through the same Section 127 plan. Tuition reimbursement, fees, books, and student loan payments all draw from the same pool. If the employer pays $3,000 toward loans, only $2,250 remains available for tuition or other qualifying assistance that year.

The cap runs on the calendar year, not a plan year or fiscal year, so cumulative benefits per employee need to be tracked through December 31. Anything paid above $5,250 becomes taxable compensation the moment it crosses the line.

Which Loan Payments Qualify

The exclusion covers payments toward principal or interest on a qualified education loan. The loan must have been taken out by the employee to pay for the employee’s own higher education at an eligible institution. Loans the employee took out for a spouse’s or dependent’s education do not qualify.³

The employer can pay the loan servicer directly or reimburse the employee.¹ When the money passes through the employee, keeping loan statements that show the payment amount and date is the practical way to substantiate that the funds actually went to a qualifying loan.

The Written Plan Requirement

The tax exclusion only exists when the employer has a formal written educational assistance program in place before payments are made. Without a written plan, every dollar the employer contributes is taxable compensation.¹

The IRS provides a template in Publication 5993.⁴ A qualifying plan has to cover a few specific points:

Who is eligible. The plan defines the group of employees who can participate, and it can extend to retired, disabled, or laid-off workers.
What the plan pays for, whether that’s tuition, student loan payments, or both.
The $5,250 annual per-employee cap and the fact that amounts above it become taxable.
A prohibition on cash alternatives. Employees cannot be allowed to choose the educational benefit over other taxable compensation. Taking the $5,250 as cash instead of a loan payment is not permitted.¹
Reasonable notice to all eligible employees about the program and its terms.¹

The plan does not have to be pre-funded. Payments can be made as they come up, without any trust or reserve account, which keeps setup light enough for small employers.¹

The plan cannot cover courses involving sports, games, or hobbies unless they relate to the employer’s business or are part of a degree program, and it cannot cover meals, lodging, transportation, or tools and supplies the employee keeps after a course ends.⁴ These limits mostly matter for tuition-side benefits rather than loan repayments, but they are part of the same plan.

Nondiscrimination Rules

A Section 127 plan cannot disproportionately favor highly compensated employees or owners. Two tests apply.³

Eligibility has to reach a broad class of employees. For 2026, an employee is highly compensated if they earned more than $160,000 from the employer in the prior year or owned more than 5% of the business at any point during the current or prior year.⁵ Eligibility rules based on job title, department, or tenure that end up screening out most rank-and-file workers while letting executives through will fail the test.

Separately, no more than 5% of the total educational assistance paid out during the year can go to the group of employees (with their spouses and dependents) who each own more than 5% of the company.¹ This concentration test blocks owner-operators from building a plan that mostly benefits themselves.

If the plan fails either test, the exclusion disappears for everyone in the plan. All payments become taxable compensation, triggering retroactive payroll adjustments and possible penalties. The IRS looks at both the plan document and how the plan is actually operated.

What Happens Above $5,250

Any amount the employer pays above $5,250 in a calendar year is treated as regular wages. It is subject to federal income tax withholding, Social Security, and Medicare tax, and it lands in Boxes 1, 3, and 5 of the W-2 alongside salary.³ The tax-free portion up to $5,250 stays out of those boxes.

For the employer, deductibility does not depend on the employee’s tax treatment. The full payment, tax-free portion and taxable excess alike, is deductible as a business expense under Section 162.²

Effect on the Student Loan Interest Deduction

Employees can normally deduct up to $2,500 of student loan interest on their personal return under Section 221. Interest that an employer already paid tax-free under Section 127 cannot be counted a second time on the employee’s return.⁶ Only interest the employee paid out of pocket, above what the employer covered, is eligible for the deduction.

That interaction is a reason to know how much of the employer’s payment went to interest versus principal. Loan servicer statements will usually break this out. The Section 221 deduction also has its own income phase-out, so higher earners may not be eligible for it at all, which leaves the Section 127 exclusion as their only tax break on loan costs.

401(k) Match on Your Own Loan Payments

Section 127 is not the only option. Under Section 110 of the SECURE 2.0 Act, effective for plan years beginning after December 31, 2023, an employer can make matching contributions to a 401(k), 403(b), SIMPLE IRA, or governmental 457(b) plan based on the employee’s own student loan payments.⁷

An employee who is putting money toward loans instead of contributing to a 401(k) can still get the employer match as if they were deferring salary into the plan. The employee certifies annually that they made the payments, and the employer deposits the match into the retirement account. The match rate and vesting schedule must match what employees receive for regular elective deferrals.⁷

The two benefits stack. An employer can pay $5,250 tax-free directly toward the loan under Section 127 and, separately, match the employee’s own loan payments into a retirement account under SECURE 2.0. One shrinks the loan balance now; the other builds retirement savings the employee would otherwise skip while paying down debt.

1
Office of the Law Revision Counsel. 26 U.S. Code 127 – Educational Assistance Programs
2
Office of the Law Revision Counsel. 26 U.S. Code 162 – Trade or Business Expenses
3
Internal Revenue Service. Frequently Asked Questions About Educational Assistance Programs
4
Internal Revenue Service. Sample Educational Assistance Program
5
Internal Revenue Service. 2026 Amounts Relating to Retirement Plans and IRAs, as Adjusted for Changes in Cost-of-Living
6
Office of the Law Revision Counsel. 26 U.S. Code 221 – Interest on Education Loans
7
Internal Revenue Service. Guidance Under Section 110 of the SECURE 2.0 Act With Respect to Student Loan Payments