The IRS released a private letter ruling (PLR) this week outlining how employers can provide a student loan repayment benefit as part of their 401(k) plan. This is a welcome development, as what is known as the contingent benefit rule has caused some confusion as to whether a student loan repayment program could be linked to a 401(k) plan.
Some employers offer a student loan repayment program that is separate from their retirement program. This can range from providing basic tools and education to employers making a regular contribution to the loan balance while employees continue to make their regular payments. Unlike tuition reimbursement benefits, however, which are tax-free below a certain amount, the employer’s loan contributions are considered taxable income. Other tools allow borrowers to upload all of their loans into the tool and see their comprehensive student loan picture and explore different repayment strategies, including federal income-driven repayment, refinancing, and extra payments. Providing a student loan repayment program separate from the retirement program creates an additional cost to employers. In response some employers have looked at coordinating student loan repayment program with their 401(k) plan to make that benefit cost-neutral.
As of the second quarter of 2018, total student loan debt obligations exceed $1.5 trillion spread across more than 44 million Americans. This vast amount of debt impacts new employees entering the workforce, career workers, and parents who have borrowed to finance their children’s education. As financial wellness becomes a common employee benefit and as employers look to manage workforce retirement planning, managing student loan debt has become an increasingly significant concern for many employers.
Historically, the contingent benefit rule (Code of Federal Regulations 1.401(k)-1(e)(6)) has restricted plan sponsors from making any benefit, other than matching contributions, conditioned (directly or indirectly) upon the employee electing to make (or not) deferrals in a 401(k) plan. As a result, many plan sponsors struggled to implement a student loan program that coordinates with the 401(k) plan. This week’s PLR provides some relief for plan sponsors seeking to implement such a benefit.
The program outlined in the PLR allows the employer to make a student loan non-elective employer contribution (SL NEC) equal to the matching contribution the employee would have otherwise received if the employee had made pre-tax, Roth 401(k), and/or after-tax contributions to the plan, so long as the employee is spending at least 2% of salary paying down student loan debt. While employees are not required to contribute to the 401(k) to receive the SL NEC, they are not precluded from participating in the 401(k) plan.
Employees who receive the SL NEC in coordination with the student loan repayment program will not be eligible to receive regular matching contributions in the 401(k) plan. The SL NEC will be subject to coverage and nondiscrimination testing, as well as contribution limits, eligibility, and vesting and distribution rules.
IRS private letter rulings are applicable only to the taxpayer requesting it. However, they can provide insight to the IRS position on plan design. By issuing this PLR, the IRS confirmed that, under certain circumstances, employers may be able to link employer contributions under a 401(k) plan to the amount of student loan repayments made by the employee outside the plan.
Bottom Line: Student loan repayment programs are becoming a meaningful tool to attract and retain key talent. This ruling applies only to the applicant and cannot be considered precedent, but it provides some direction on similar benefit innovations. Notably, employers who wish to explore a similar offering should review their 401(k) plans for features or design elements that might conflict with a student loan repayment benefit (e.g., safe harbor plans).
