Is Relief on the Way for Student Loan-Saddled Retirement Plan Participants?
Three Things You Should Know About the Recent IRS Ruling
Earlier this year, we wrote about the reality many plan participants face: deciding between saving for retirement or paying down debt – debt which often includes burdensome amounts of student loans. How bad is it? The most recent data suggests that total student loan debt stands at $1.48 trillion, which is spread out amongst 44.2 million Americans. That works out to roughly an average of $33,484 worth of debt per borrower – a staggering statistic by any measure.[1]
However, an interesting development took place on August 17 when the IRS issued a private ruling[2] that allowed an unnamed company to move forward with a new benefit for student loan borrowers in their 401(k) plan. The ruling may provide hope for those borrowers who have postponed saving for retirement and chosen to pay down their higher education debt instead. Here’s what you should know about the ruling.
The Basics – The unnamed employer referenced in the ruling proposed amending their plan in a way that would encourage employees to repay student loans and avoid falling behind on their retirement savings. Under the plan, as long as employees can prove that they are paying at least two percent of their salary toward student loan debt, the employer will make a non-elective contribution equal to five percent of their salary to their retirement plan, even if those employees don’t actively contribute to their 401(k).
The Technical Details – So, how does it work? In the tax code that governs retirement plans such as 401(k)s, there is something known as the “contingent benefit” rule. The rule essentially says that employers generally cannot make benefits contingent on an employee making salary deferral contributions, with the exception being an employer matching contribution. In this ruling, the IRS determined that the contribution from the employer based on the student loan repayment does not violate the contingent benefit provision.
What Does This Mean? – While this could signal future changes to student loan benefits in 401(k) plans on a larger scale, it’s important to note that this particular ruling is specific to the employer who filed the ruling proposal. Meaning the ruling isn’t the law of the land for all 401(k) plans, but rather a carve-out for that employer. If other plan sponsors wish to implement an identical approach, they would be required to seek individual approval from the IRS via a Private Letter Ruling (PLR) request – a process that may be cost-prohibitive for many plan sponsors.
The fact that the PLR encourages a creative approach to helping employees meet their student loan obligations while saving for retirement is a welcome development. Yet, while highly encouraging, it is not as revolutionary from a plan design perspective. Why? Because with proper plan design, a plan sponsor always has the ability to use her own criteria for making non-elective contributions. The IRS simply clarified that because the non-elective contributions were conditioned on an employee making a loan payment outside of the plan, did not depend on whether or not an employee made salary deferral contributions into the plan, and didn’t preclude an employee from making salary deferral contributions into the plan, this approach was acceptable.
Can plan sponsors implement a similar strategy without going down the path of requesting a PLR? Quite possibly.
Here’s a path to consider. A contribution conditioned on student loan repayments is a non-elective employer contribution. Employer could elect to make discretionary non-elective contributions (similar to profit sharing) and put every participant in their own allocation group. Then, the employer could allocate special contributions to those participants who meet the terms of its student loan repayment program. If a more formulaic approach is desired, a fixed contribution formula may be written into the plan for those who satisfy conditions of the student repayment program.
There are a few other important things to think about:
- How may a student loan repayment program impact salary deferral contributions, especially those made by the non-highly compensated employees? Will it negatively impact deferral percentage and matching contribution non-discrimination tests?
- Since non-elective contributions made into the plan are subject to non-discrimination testing, how will it affect non-discrimination test of employer non-elective contributions, especially if a program benefits a large percentage of employees classified as highly compensated? (Note, the first two issues are especially impactful for small plans).
- How should vesting rules apply to these non-elective contributions?
- How to clearly articulate and communicate the qualification requirements, conditions, and terms of the student loan repayment program in employee materials?
As it stands today, while small in scale, this recent development is highly encouraging; not only to employers who are seeking to attract talent, but also to employees who are struggling to grapple with the choice between paying off student loans and saving for retirement. If more employers follow suit with similar programs, student loan borrowers may be better positioned to catch-up on retirement savings they’ve chosen to hold off on. Please continue to check back for any additional updates to this story, including any additional guidance from the IRS.
For discussion purposes only and in no way represents legal or tax advice. For advice regarding your specific circumstances, the services of an appropriate legal or tax advisor should be sought.
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