Many entering the job market fresh from college are burdened by student loan debt. In fact, this problem can linger on for college graduates well into their professional life. The amount of debt can be staggering. Employees with student debt have a difficult choice: if they focus on paying off student loan debt, they may not be able to afford to make contributions to their employer’s 401(k) plan. It also means that they may miss out on matching contributions the employer provides. This impairs an employee’s ability to get a good start on retirement savings. Some employers have tried to assist employees with student loan debt by providing reimbursements for student loan payments. However, this approach results in taxable income to the employee and may not increase 401(k) participation.
In Private Letter Ruling (“PLR”) 201833012, the Internal Revenue Service (the “IRS”) approved an arrangement where the employer contributes matching amounts into the 401(k) plan of employees who make student loan payments. So, while the employees are making payments to pay off student loans, they are also getting contributions made to the 401(k) plan. While a private letter ruling is binding on the IRS only for the specific individual or entity that the letter is issued to, and rulings are specific to the facts in that case, it does indicate the direction of IRS thinking on the issue.
Facts of the PLR
The employer in the PLR offered an unusual matching contribution: if the employee elects to contribute at least 2% of compensation (either as a pre-tax, after tax or Roth contribution), the employer makes a matching contribution equal to 5% of the employee’s compensation (the “regular match”). In lieu of the regular match, the employer proposed to offer employees who have student loan debt the opportunity to receive a non-elective employer contribution (the “student loan contribution”) equal to 5% of compensation under the 401(k) Plan which is conditioned upon the employee making student loan payments of at least 2% of compensation. Employees who elect to receive the student loan contribution can also make elective contributions, but they cannot receive a match on those contributions. Employees can receive either the student loan contribution or the regular match, but not both, for any pay period. Receipt of the student loan contribution is voluntary and the employee can opt out prospectively at any time.
The Contingent Benefit Rule
The issue addressed in the PLR is whether the arrangement proposed by the employer violates the contingent benefit rule (Code Section 401(k)(4)(A) and Regulations Section 1.401(k)-1(e)(6)). Under this rule, a 401(k) plan cannot make the receipt of any benefit other than matching contributions conditioned (directly or indirectly) on the employee electing to make or not make elective contributions under the plan. The PLR reasoned that since the student loan contribution is conditioned on the employee making a student loan payment, the contribution is not conditioned on the employee making elective contributions to the plan. In addition, the ruling concluded that employees who elect to receive the student loan contribution may still make elective contributions, so the student loan contribution is not conditioned on the employee not making elective contributions. Based on this analysis, the IRS found the arrangement did not violate the contingent benefit rule.
The arrangement described in the PLR has nondiscrimination testing ramifications:
Ordinarily an employer matching contribution will satisfy the nondiscrimination requirement of Code Section 401(a)(4) by passing the actual contribution percentage test or ACP test. However, the student loan contribution described in the PLR is not a matching contribution for this purpose, and so is not included in ACP testing. Instead it is a non elective employer contribution.
Because the student loan contribution will likely not satisfy any of the uniform allocation safe harbors under Section 401(a)(4) for employer contributions under a defined contribution plan, the plan may need to use the general test to show that the contribution is nondiscriminatory.
The offer of a student loan contribution could result in employees making bigger student loan payments and less, or no, elective deferrals, and so negatively impact ADP and ACP testing results.
The PLR does not address many issues of interest and import for employers, including:
As noted above, a PLR is limited to the specific facts, and it is not completely clear as to which facts in the PLR are critical, so in situations where one or more of the facts are different, the arrangement may or may not comply with the requirements of Code Section 401(k).
Specific administrative issues such as what type of documentation of student loan payments would be required are not addressed.
It is also not clear whether similar arrangements where benefits are contingent upon payments for purposes other than student loan repayment would be permitted.
The Take Away
This new ruling potentially opens the door for retirement plans to allow employees to focus on paying off their student loan debt and save for their retirement at the same time. For employers, the approach described in the ruling is an innovative way to offer relevant benefits to their workforce. Interested employers may want to design their own arrangement, taking into consideration their employee population and the impact on testing as described above. While the PLR is helpful, the issuance of generally applicable guidance from the IRS would be a welcome development.
© Boutwell Fay LLP 2018, All Rights Reserved.This handout is for information purposes only, and may constitute attorney advertising. It should not be construed as legal advice and does not create an attorney-client relationship. If you have questions or would like our advice with respect to any of this information, please contact us.The information contained in this article is effective as of September 28, 2018.