HIGHLIGHTS:

  • With growing student loan debt pushing employees to delay contributing to their employers' 401(k) plans, many employers have been looking for ways to help their employees save for retirement.
  • A recent Internal Revenue Service (IRS) Private Letter Ruling may provide one method for employers to make a contribution to 401(k) plans on an employee's behalf if a certain percentage of the employee's compensation is used for repaying his or her student loan debt.
  • While it is certainly welcome news, employers must consider many other factors in deciding if such a program is right for them.

With growing student loan debt pushing employees to delay contributing to their employers' 401(k) plans (as well as delaying major life events such as buying a home, getting married and starting a family), many employers have been looking for ways to help their employees save for retirement. One proposed method is for employers to make a contribution to 401(k) plans on an employee's behalf if a certain percentage of the employee's compensation is used for repaying his or her student loan debt.

A recent Internal Revenue Service (IRS) Private Letter Ruling surmounts one perceived legal hurdle. However, despite all of the positive media coverage that has been issued, there remain a number of other obstacles to overcome.

The Ruling

In Private Letter Ruling 201833012, the IRS reviewed a company's program that provided the following employer contributions for an employee who was employed on the last day of the plan year (or terminated employment during the plan year due to death or disability):

  • if the employee makes a student loan repayment during a pay period equal to at least 2 percent of his or her eligible pay for that pay period, the employer will make a nonelective contribution to the plan at the end of the year equal to 5 percent of the employee's eligible pay during that pay period (student loan repayment nonelective contributions)
  • if the employee does not make a student loan repayment during a pay period equal to at least 2 percent of his or her eligible pay for that pay period, but does make an elective contribution of at least 2 percent of his or her eligible pay during that pay period, the employer will make a matching contribution at that end of the year equal to 5 percent of the employee's eligible compensation for that pay period (true-up matching contributions)

Section 401(k)(4)(A) of the Internal Revenue Code of 1986, as amended (Code), provides that a 401(k) plan will not be tax-qualified if any benefit other than matching contributions "is conditioned (directly or indirectly) on the employee electing to have the employer make or not make contributions under the arrangement in lieu of receiving cash." The company requested a Private Letter Ruling (PLR) that its program did not violate this contingent benefit prohibition under Code Section 401(k)(4)(A) and the regulations thereunder.

In this PLR, which is only applicable to the party that requested it, the IRS held that there was no violation of the contingent benefit prohibition because:

  • the student loan repayment nonelective contributions were contingent on the employee making student loan repayments, not directly or indirectly on the employee electing to make contributions under the plan
  • employees who make student loan repayments are still permitted to make elective contributions to the plan

Qualification Issues

The PLR did not address whether the proposed contributions, when taken in conjunction with other plan provisions, would meet the qualification requirements of Code Section 401(a). Such contributions may cause certain plans to fail coverage testing under Code Section 410(b) and/or nondiscrimination testing under Code Section 401(a)(4).

  • Coverage. The student loan repayment nonelective contributions would have to pass coverage testing under Code Section 410(b) and nondiscrimination testing under Code Section 401(a)(4). With nonelective contributions, an employee is treated as covered only if the employee's account is actually credited with nonelective contributions.1 Depending on the employee demographics, the percentage of highly compensated employees2 who would receive student loan repayment nonelective contributions compared to the percentage of nonhighly compensated employees who would receive this benefit may cause a plan to fail coverage testing. Employers might have to limit the highly compensated employees eligible to receive student loan repayment nonelective contributions in order to pass coverage testing.
  • Nondiscrimination. For purposes of nondiscrimination testing under Code Section 401(a)(4), employees who do not make the required level of student loan repayments to receive student loan repayment nonelective contributions will be included in testing as having zero nonelective contributions (unless the employer makes another type of nonelective contribution on the employee's behalf). Employers might have to limit the highly compensated employees eligible to receive student loan repayment nonelective contributions or the amount of such contributions they receive in order to pass nondiscrimination testing.
  • Safe Harbor. Many 401(k) plans avoid nondiscrimination testing of elective deferrals, after-tax contributions, and matching contributions by meeting safe harbor requirements. Safe harbor plan design can be based on either employer matching contributions or employer nonelective contributions. Making true-up matching contributions only for participants who make a certain level of employee contributions means that the plan cannot be a safe harbor plan based on matching contributions. Plans that were previously safe harbor may have to perform annual nondiscrimination testing and/or significantly change their plan design.

Conclusion

While it is certainly welcome news that student loan repayment nonelective contributions are not a per se violation of the contingent benefit prohibition under the Code, employers must consider many other factors in deciding if such a program is right for them. The difficulty, uncertainty and costs involved in passing coverage and nondiscrimination testing each year may be a deal-breaker for some employers. Also, employees who have been delaying major life events may place greater value on additional pay that is not contingent on repayment of student loan debt. Employers should evaluate whether making student loan nonelective contributions is the best use of their funds in attracting and retaining desired employees.