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IRS Allows 401(k) Match for Student Loan Repayments

(posted: August 27th, 2018)

A new IRS ruling approves an employer's plan to help workers save for retirement while paying off student loans.

On Aug. 17, the IRS made public its Private Letter Ruling (PLR) 201833012, which was issued to the requesting company on May 22. The letter responds to an employer (which turns out to be Abbott Laboratories) that proposed amending its 401(k) plan to offer a student-loan benefit program under which it would make special 401(k) contributions into the accounts of employees who are making student loan repayments.

It is expected that this new ruling will encourage retirement savings by employees, especially the younger generation.

According to research by the Pew Charitable Trusts, only slight more than half of Millennials at 52%, participate in their company retirement plans. At the same time, a staggering $1.4 trillion is owed in student loan debt in this country, even more than auto loan debt or credit card debt.

At Abbott, a research and development company, full- and part-time employees who qualify for the company's 401(k) and contribute 2 percent of their eligible pay toward their student loans through payroll deductions receive an amount equivalent to the company's 5 percent 401(k) match deposited into their 401(k)s. Program recipients receive the match without being required to make any 401(k) contributions of their own, allowing them to use more of their earnings to pay off student debt.

"The benefit responds to recent financial challenges facing young employees...and adds to the strong appeal of joining the Abbott family," the company stated in a July news release.

When adopting this approach to student loan repayment aid, Abbott suggested that the benefit was starting to go mainstream, despite a lack of IRS guidance. And Abbott certainly wasn't the first employer to offer this benefit. Prudential Retirement, a provider of 401(k) plan administration services, began doing so in 2016.

"As student loan debt grows, workers are having to choose between paying off their student loans or prioritizing other important financial goals," said Jamie McInnes, senior vice president for Prudential Retirement. "Our research tells us many workers will choose to pay down debt rather than save for retirement."

Key features of the 401(k) plan approved by the IRS include the following:

  • Participation is voluntary. If an employee signs up for the student loan repayment program, he or she receives a nonelective contribution for each pay period in which a student loan debt payment is made.
  • The employer contribution is equal to the matching contribution the employee would otherwise receive if the employee made contributions to the plan during the same payroll period.
  • The student loan repayment benefit effectively replaces the employer matching contribution for an employee who chooses to participate in the program. Thus, the employee is not eligible for other 401(k) matching contributions.
  • The student loan repayment benefit is subject to the other rules for 401(k) plans, including contribution limits and nondiscrimination requirements.

It's Tax-Free, but What About the Contingent Benefits Prohibition?

Unlike student loan repayment (SLR) dollars given directly to employees, which are treated as taxable income, employer 401(k) contributions are not taxable. As a result, this approach achieves tax advantages like those associated with traditional tuition-reimbursement benefits but generally denied to student loan repayment benefits. A lingering question, however, has been whether this is legal.

The IRS ruling addressed a major employer concern by stating that the proposal to provide student loan repayments through an employer's contributions to the 401(k) accounts of employees who are repaying student loans "would not violate the 'contingent benefit' prohibition of section 401(k)(4)(A) and section 1.401(k)-1(e)(6)" of the tax code.

Under the contingent benefits rule, an employer may not make other benefits, such as health insurance, stock options, or similar entitlements, contingent on a participant's making elective deferrals under a 401(k) plan.

The ruling held that because the employer's 401(k) contributions are triggered by employees' student loan repayments, they did not violate the contingent benefit rule.

Limited Scope

It's important to note that an IRS ruling is directed only to the employer requesting it and may not be cited as precedent, although it does suggest how the IRS may approach this matter in future guidance.

The ruling can be seen as providing confirmation that such an arrangement is permissible under certain circumstances. A 401(k) student-loan match will not work if the plan sponsor is actually providing the student loans that are being repaid, and probably won't work with a safe-harbor 401(k) plan.

Possible Issues to Consider

Notably, the ruling does not address any of the finer details of the Internal Revenue Code that must be considered with such a arrangement, such as how the benefit might interact with 401(k) plan eligibility, vesting, and distribution rules, and annual coverage and nondiscrimination testing to ensure that the 401(k) plan does not favor highly compensated employees.

The fact that generally non-highly compensated employees are making student loan repayments rather than 401(k) elective contributions may negatively affect ADP or ACP testing results, reducing the amount that could be contributed by or for highly compensated employees.

Employers would need to work to determine how an SLR program might be structured without causing the plan to fail coverage and nondiscrimination requirements.

Will We See More Companies Doing This?

Despite these challenges, it seems likely that vendors that help employers contribute toward student loan repayments will move to establish and market versions of the SLR non-elective contribution program described in the private letter ruling.

In hopes of getting further guidance, the ERISA Industry Committee (ERIC), which advocates on behalf of large employers, sent the IRS a letter asking that it broaden the reach of PLR 201833012 to enable all sponsors of 401(k) plans to make similar contributions that offset employees' student-loan repayments.

"The recently issued PLR is a significant step in right direction, but ERIC believes that more employers would be encouraged to implement retirement savings programs to assist individuals who are repaying student loans, similar to the one described in the PLR, if the IRS would issue a revenue ruling or other guidance of general applicability on this issue," wrote Will Hansen, ERIC's senior vice president of retirement and compensation policy.

Until the IRS issues expanded guidance, we recommend that employers wishing to put such a program in place consult their legal counsel to assess potential liability.

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