By combining a 401(k) plan with student loan repayments, this approach may provide employers an opportunity to help employees meet student loan obligations without adding a costly new program.
It is estimated that there is currently $1.5 trillion in student debt owed by 44 million borrowers in the U.S.
A recent IRS private letter ruling (PLR 201833012) approved an innovative approach that allows employees to balance student loan repayments with saving for retirement.
By combining a 401(k) plan with student loan repayments, this approach may provide employers an opportunity to help employees meet student loan obligations without adding a costly new program. Here is an explanation of the program approved by the IRS — and an overview of some of the opportunities created by this ruling.
Basic Plan Design: Before and After
The plan in question permitted employees to make (i) pretax deferrals, (ii) Roth after tax contributions, or (iii) “traditional” after tax contributions. If an employee saves at least 2 percent of pay into the plan, the employee receives a match of 5 percent of pay.
The employer modified this basic plan design by adding a student loan repayment (“SLR”) feature. Under this feature, if an employee makes a student loan repayment equal to at least 2 percent of pay, the employee will have the opportunity to receive the employer 5 percent contribution in the form of a “nonelective” employer contribution to the retirement plan (referred to as an “SLR nonelective contribution”). In effect, if employees are engaged in the “desired” behavior — either saving for retirement or paying off student loans — the employees receive 5 percent of pay toward retirement.
Here are a few points to note:
• Employees can get only one 5 percent employer contribution. But now, employees can earn that 5 percent contribution either by saving for retirement or by repaying student loans.
• The student loan repayment is not paid into the 401(k) plan. Rather, the repayment occurs outside of the 401(k) plan — but that loan repayment of 2 percent of pay allows the employee to get the 5 percent of pay employer contribution (in the form of the SLR nonelective contribution) and the SLR nonelective contribution is paid to the 401(k) plan.
• Employees making student loan repayments remain eligible to contribute to the employer’s 401(k) plan.
• The employer 5 percent contribution is considered a matching contribution if the employee contributes into the 401(k) plan; however, if the employee makes a 2 percent student loan repayment, then the employer’s 5 percent SLR nonelective contribution is not considered an employer matching contribution under IRS rules and is not subject to ACP testing.
• The employer 5 percent SLR nonelective contribution is subject to all applicable retirement plan rules (such as vesting and restrictions on distributions).
Implications and Conclusions
It is important to note that private letter rulings do not represent formal IRS guidance and cannot be relied upon by any employers other than the recipient of the letter. However, private letter rulings do reflect the IRS’ thinking on an issue and it is not uncommon for employers to use private letter rulings as a roadmap in the absence of more formal guidance.
However, even after that caveat, this private letter ruling offers employers an opportunity to simultaneously help employees meet student loan obligations and build retirement savings. Moreover, although there are some legal issues that would have to be addressed (such as plan documentation, employee communication and ACP testing implications), adopting this approach should not require a large employer effort or cost. It should also be noted that this approach could also be extended to a 403(b) plan.
Benefits professionals are often mired in the challenges of meeting compliance requirements. It is a welcome change of pace to consider ways to revise retirement plans to better meet employee and employer needs.