Many recent college graduates find it difficult to make contributions to their employer’s 401(k) plan as they have significant student loan repayments which take precedence in their budget. By failing to make 401(k) deferrals, these employees may miss out on employer matching contributions as well as earnings on the deferrals and match.
The IRS has issued a recent Private Letter Ruling (PLR 201833012) that may allow these employees to receive an employer contribution that is conditioned on making a certain level of student loan repayment rather than making a deferral contribution to the plan. Under the student loan repayment (“SLR”) program:
- All employees are eligible and can voluntarily enroll in the program. An employee can opt out of the program on a prospective basis.
- If an employee enrolls in the program, the employer will make an “SLR nonelective contribution” at the end of the plan year equal to 5% of the employee’s eligible compensation for each pay period in which the employee made a student loan repayment at least equal to 2% of the employee’s eligible compensation.
- If the employee does not make a student loan payment in a pay period but makes an elective deferral of at least 2% of his/her eligible compensation in the pay period, the employer will make a “true-up” matching contribution at the end of the plan year. The employee must be employed on the last day of the plan year (except for a termination due to death or disability) to receive either the SLR nonelective contribution or the true-up matching contribution.
- The SLR nonelective contribution and true-up matching contribution are subject to the same vesting schedule that applies to regular matching contributions.
- If an employee opts out of the program, he/she will resume eligibility for regular matching contributions under the plan.
In the PLR, the IRS ruled that the SLR program would not violate the “contingent benefit” rule of Section 401(k)(4)(A) of the Internal Revenue Code and Treas. Reg. § 1.401(k)–1(e)(6). This rule otherwise prohibits employers from making non-401(k) benefits (e.g., other compensation, welfare, or stock option benefits) contingent on employees deferring or not deferring compensation into a 401(k) plan. If the SLR program was treated as “conditioned” upon the employee electing to make (or not make) contributions, it could cause the plan to lose its preferential tax treatment. The IRS ruled that the SLR nonelective contributions as discussed in the PLR were conditioned on making student loan payments, not on making elective contributions. Additionally, employees who made student loan payments were still permitted to make elective deferrals under the proposed program.
Employers should note that PLRs may not be used or cited for precedent. Employers may use the PLR, however, as a helpful guidepost in designing these programs. It is critical, however, that employers consult with an experienced benefits attorney prior to establishing these programs, as the IRS will not issue determination letters on existing plans that are amended to provide student loan benefits.