There are several qualification requirements for an employer’s cash or deferred arrangement under Section 401(k) of the Internal Revenue Code of 1986, as amended (Code). One such requirement is that benefits may not be contingent (either directly or indirectly) on an employee’s election to make (or not make) elective contributions to the employer’s arrangement. This requirement is frequently referred to as the “contingent benefit rule.” The Code includes an express exception to the contingent benefit rule for employer matching contributions. Matching contributions may be conditioned upon an employee’s election to make elective contributions.
On August 17, the Internal Revenue Service (IRS) issued guidance in Private Letter Ruling (PLR) 201833012, indicating that the student loan repayment (SLR) program that a 401(k) plan sponsor (the PLR Employer) proposed to add to its 401(k) plan would not violate the contingent benefit rule. Under the PLR Employer’s proposed design, a participant who makes an elective contribution of at least 2% of eligible compensation in a pay period will receive a matching contribution of 5% of eligible compensation in that pay period. However, if the participant enrolls in the student loan benefit program under the plan and makes an SLR of at least 2% of eligible compensation in a pay period, he or she will receive, instead of the matching contribution, a nonelective contribution of 5% of eligible compensation for that pay period (paid after the end of the year). Regardless of whether a participant enrolls in the student loan benefit program, he or she is eligible to make elective contributions.
The PLR described several features of the employer’s student loan benefit program, noting that the program is voluntary, employees enrolled in the program may opt out of the program prospectively, and SLR nonelective contributions are subject to the same vesting schedule as matching contributions and subject to applicable plan qualification requirements. The employer also had not extended and had no plans to extend any student loans to employees that would be eligible for the program.
In concluding that the employer’s student loan benefit program did not violate the contingent benefit rule, the IRS emphasized the fact that the SLR nonelective contributions were contingent upon an employee making an SLR, and not on whether the employee made an elective contribution to the 401(k) plan.
One caveat to note, of course, is that PLRs, which are issued by the IRS in response to individual taxpayer requests for guidance, are binding only between the requesting taxpayer and the IRS. Though PLRs may not be cited as precedent or relied upon by other taxpayers, they do give insight into the IRS’s view and potential interpretation of the law with respect to similar sets of facts. Thus, this PLR is a positive sign for other plan sponsors considering adding a similar feature to their 401(k) plans.
It is a fact of modern life that many young employees struggle with significant student debt. An employer that is encouraged by the PLR to explore ways it may help its employees pay off student debt through its 401(k) plan should carefully consider the design of any contribution it may introduce. The contribution will surely have to be a nonelective contribution, as in the case in this PLR, and will be subject to the same qualification rules as any other plan contribution, including eligibility, vesting, and distribution requirements, as well as nondiscrimination testing. And while one may assume that nondiscrimination testing will not be necessary since most young employees are not highly compensated, pay scales are higher in some industries than others, and in some cases young employees may well reach the highly compensated threshold ($120,000 in 2018) and beyond within the period of time that they maintain student debt. The PLR Employer minimized nondiscrimination concerns by using a safe harbor when designing the nonelective contribution: the same percentage of compensation is allocated for all eligible participants. Contributions designed under a safe harbor are considered nondiscriminatory.
Despite the potential challenges, the addition of this type of feature to a plan sponsor’s 401(k) plan would certainly be a welcome benefit to employees, especially those who feel as though they have to choose between saving for retirement and paying down student loan debt. An SLR program could effectively eliminate that choice and make it easier for employees to do both—enjoy the benefit of tax-deferred growth on the SLR nonelective contributions for retirement while simultaneously tackling student loan debt.