As student loan debt balloons, employers are struggling with how to help employees address the burden of debt without sacrificing retirement savings. There was proposed legislation in Congress that would allow retirement contributions on behalf of 401(k) plan participants that are making student loan repayments, but it did not make it into law.
However, given the need to attract and retain talent, employers are not waiting on Congress to move forward, even to the point of charging into gray areas of the law. In Private Letter Ruling (PLR) Number 201833012, one such employer was able to get some additional clarity. In that PLR, the IRS removed one potential hurdle to U.S. employers giving their workforces retirement contributions based on student loan repayments. Although the ruling only applies to the employer that requested the letter, PLRs can be a helpful indicator of IRS policy position and are sometimes a preview of future guidance.
Under the arrangement proposed in the letter, an employee could receive a non-elective employer contribution if he or she was actively repaying a student loan. This arrangement allows employees to receive a match-like contribution in the plan, even if student loan repayments make it impossible for them to make 401(k) contributions. Using this benefit, they would not be faced with the Hobson’s choice of repaying student debt or saving for retirement; they could do both at once!
So what’s the issue?
The 401(k) rules generally say that no benefit (except for a match) can be conditioned on making 401(k) contributions (or not making them). In other words, employers cannot “encourage” employees to make 401(k) contributions, or alternatively discourage them to from making 401(k) contributions, by providing other benefits. This is called the “contingent benefit rule.” The contingent benefit rule specifically says that non-elective contributions cannot be conditioned on someone contributing, or not contributing, to the plan. Congress did not want employers to try and avoid nondiscrimination testing issues, or limit participation, by giving some employees an incentive to contribute and others an incentive not to contribution.
Now you see the issue: providing a non-elective contribution for someone who is making a student loan repayment instead of making a 401(k) contribution could be seen as encouraging them not to contribute to the plan. If the contribution violated the contingent benefit rule, that would disqualify the 401(k) arrangement and, most likely, the entire plan. That would be a catastrophe. Fortunately, the IRS did not see it that way.
Plan modification details
The specifics of the program were:
- Participants making verified student loan repayments would receive a non-elective contribution. Even though the contribution functions like a matching contribution on student loan repayments, under the 401(k) rules, matching contributions can only be made on 401(k) or employee after-tax contributions.
- The program is voluntary and open to all employees.
- The regular matching contribution under the plan is five percent of compensation per payroll period. An employee receives that for contributing at least two percent of compensation for that pay period. These matching contributions are made each pay period.
- If an employee instead chooses the student loan program, the employee would forego the regular matching contribution. Instead, the employee would receive a non-elective contribution of five percent of the employee’s pay for the payroll period for making a student loan payment of at least two percent of eligible compensation for the pay period. The employer would make its contribution at the end of the year.
- If the employee’s student loan repayment was not at least two percent of compensation for the pay period, the employee could make an additional 401(k) contribution. If the 401(k) contribution was at least two percent of compensation for that pay period, then the employee would get a five percent true-up matching contribution at the end of the year. This feature was presumably designed to make sure employees can still get the benefit of the full matching contribution if their student loan payment falls below two percent of compensation (such as due to a raise or the loan being paid off).
- The employee can choose to go back to receiving regular matching contributions at any time.
- All matching and non-elective contributions would have the same vesting schedule.
- The employer would not provide student loans to employees.
The IRS said the arrangement would not violate the contingent benefit rule. Financially speaking, an employee might have to choose between student loan repayment and making 401(k) contributions. However, the IRS recognized that the program described above does not discourage them from contributing to the 401(k) plan. In the IRS’s view, the non-elective contribution is conditioned on making student loan repayments, and not on anything else.
The IRS also said its ruling was based on the assumption that the employer would not extend student loans to employees who were eligible for the program. This is an important point. If the employer extended student loans, then it would be providing an incentive for employees not to choose the student loan repayment over the regular match.
Additionally, the PLR only addressed the contingent benefit rule issue. The ruling did not address other tax code requirements, such as vesting requirements, distribution rules, and nondiscrimination testing.
Why is this important?
As noted above, even though the PLR is only valid for the employer that asked for it, the letter represents the first meaningful IRS involvement in this area. As such, it raises new optimism that expanded opportunities for student loan repayment may become available. In addition, the PLR may spur other organizations into experimenting in similar ways.
Because the PLR only applies to that employer, prudent employers should tread carefully in setting up similar student loan repayment solutions and consult with experienced ERISA counsel in this area. We invite you to schedule a meeting with your HUB advisor to discuss the matter and look at this and other alternatives.
Summit Financial Corporation
A HUB International Company
700 District Avenue
Burlington, MA 01803
Tel: (781) 229-9500
Fax: (781) 229-2700
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