IRS Approves the Use of a 401(k) Plan to Help Tackle Student Loan Debt

Employee Benefits Alert

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The Internal Revenue Service (IRS) has issued a private letter ruling approving of an employer’s program to provide employees a retirement plan contribution conditioned on student loan repayments. Specifically, the IRS found that such contributions will not violate the “contingent benefit” prohibition under the Internal Revenue Code and related Treasury Regulations. Although the ruling only applies to the employer who requested it, it serves as welcome guidance and a helpful roadmap to employers looking for a tax-advantaged option to assist employees with their student loans.

How does the student loan repayment program work?

The plan reviewed under the ruling allows for elective contributions (401(k) deferrals) to be made each payroll period and provides for a payroll-by-payroll matching contribution of 5 percent of a participant’s compensation if he or she makes elective contributions of at least 2 percent of compensation. In lieu of this “regular match,” employees may instead elect to participate in the “student loan repayment program” (SLR program) under which they will receive an annual “SLR nonelective contribution” and/or a “true-up matching contribution.” Employees receive an SLR nonelective contribution equal to 5 percent of their compensation for each payroll period they make a student loan repayment equal to at least 2 percent of their compensation. To the extent employees enrolled in the program do not make a sufficient student loan repayment during a pay period but do make elective contributions of at least 2 percent of their compensation, they will instead receive an annual true-up matching contribution equal to 5 percent of their compensation for such period(s). In other words, the employer will “match” either an employee’s student loan repayments or elective contributions.

What are the benefits of an SLR program?

Put simply, an SLR program allows employees to focus on paying off their student loans without sacrificing an employer contribution to their retirement plan. Beyond the obvious value as a recruitment and retention tool, particularly for younger, well-educated workers, this type of student loan repayment program provides significant tax advantages to both the employer and employee that alternative student loan repayment benefits cannot replicate. For example, some employers have adopted programs that offer employees a cash benefit equal to a flat-dollar amount or a percentage of the employee’s salary to be dedicated to student loan repayment. Unlike the payments under these other programs, an employer contribution under a SLR program would not be subject to FICA and FUTA and would not, at least initially, be subject to federal income tax withholding, provided other requirements under the Internal Revenue Code are met.

What does the IRS ruling say about SLR programs?

The ruling answered the threshold question of whether a student loan repayment program could work in a 401(k) plan under any structure without violating the “contingent benefit” prohibition under Internal Revenue Code Section 401(k)(4)(A) and Treasury Regulation Section 1.401(k)-1(e)(6). This rule generally provides that an employer cannot offer any benefit, other than a matching contribution, that is conditioned (directly or indirectly) on an employee making elective contributions to a 401(k) plan. The IRS concluded that the rule would not be violated by the employer’s program because (1) the SLR nonelective contributions were conditioned on student loan repayments, not elective contributions, and (2) employees receiving SLR nonelective contributions could still make elective contributions in the same amounts.

What issues remain for employers who want to adopt an SLR program?

While the ruling affirmed that an SLR program could work, employers must still tackle several issues before knowing whether an SLR program will actually work for them. As an initial matter, some employers may lack the flexibility under their pre-approved 401(k) plan document to structure a contribution based on student loan repayments. Other employers may be unwilling to deal with the added costs or administrative issues involved with such a program.

Assuming an employer has a sufficiently flexible plan, the employer will need to work closely with its recordkeeper to determine how an SLR program may be structured without causing the plan to fail coverage and nondiscrimination requirements. As part of this process, employers will want to consider the impact of such requirements not only on contributions under the SLR program but also on other contributions that may be affected by employees’ utilization of the SLR program. For example, contributions under an SLR program would seem likely to result in lower elective contributions and lower regular matching contributions being made for non-highly compensated employees. As a result, the plan’s compliance with ADP and ACP nondiscrimination tests, respectively, could be affected. Finally, regardless of the structure of an employer’s SLR program, the employer’s 401(k) plan will need to be amended to provide for the program.

If you have any questions about the ruling or SLR programs, please contact one of the attorneys in the Employee Benefits and Executive Compensation Practice Group at Bradley.