In a new private letter ruling (PLR 201833012) released August 17, 2018, the IRS approved amendments to a 401(k) plan that effectively permit the employer to treat an employee’s student loan repayments similar to elective contributions under the plan by making a nonelective employer contribution equal to the matching contribution the employer would have made, if instead of making the loan repayments, the employee made elective contributions of the same amount. The plan at issue provided that if an employee made an elective pre-tax, Roth, or after-tax contribution of at least 2% of compensation during a pay period, the employer would provide a 5% matching contribution. The employer proposed to amend the plan to provide for a student loan repayment (SLR) benefit whereby if an employee enrolled in the SLR program and paid back student loans in an amount that was at least 2% of compensation during the pay period, the employer would make a nonelective employer contribution of 5% of compensation regardless of whether the employee made elective deferrals under the plan. However, any elective deferrals also made while participating in the SLR program would not be eligible for matching contributions. The SLR nonelective contributions would be subject to the same vesting schedule as the matching contributions.
The employer asked the IRS to rule that the proposed amendment to the plan to add the SLR program nonelective contributions would not violate the prohibition against “contingent benefits” under the 401(k) regulations. Those regulations provide if a benefit is conditioned on an employee electing or not electing to make elective contributions to a 401(k) plan, the plan will not be considered a qualified cash or deferred arrangement under section 401(k) of the Internal Revenue Code. The IRS ruled the SLR nonelective contributions are conditioned on the employee making student loan repayments, not elective contributions under the plan. Therefore, the regulations would not be violated.
Key facts in the ruling were that the SLR program was subject to all applicable plan qualification requirements such as eligibility, coverage and nondiscrimination testing. Nevertheless, this ruling authorizes a plan design to help employees who have significant student loan debt that might prevent them from otherwise participating in the employer’s 401(k) plan. It effectively gives employees credit for student loan repayments as if they were elective contributions. The ruling does not discuss what constitutes eligible student loan repayments. For example, does a parent’s loan for his or her child’s college education qualify for either the parent as the employee-participant? Nor does it address any loan repayment substantiation requirements.
It is also important to note that the employer already had a fairly generous plan formula (5% match on a 2% employee contribution). Many employers only match employee contributions on a dollar for dollar basis and some provide no match at all. Additionally, it seems that if the employer had a significant number of employees enroll in the SLR program and not make any elective contributions to the plan because that money was used to make the student loan repayments, the plan could have difficulty passing the ADP test. Still under the right circumstances this new plan design could be a tremendous benefit for employers to attract recent graduates who are saddled with significant student loan debt.
The Federal Reserve reports that student loan debt in the U.S. reached 1.5 trillion dollars in the first quarter of 2018, which is more than double the credit card debt. Additionally, the average student loan debt is over $37,000. This SLR program plan design, as authorized by the ruling, is a welcome tool that may help fight this crisis. While a private letter ruling is technically only binding on the taxpayer that requested it, they do provide the reasoning of the IRS and there is no reason to believe the IRS would take a different position with respect to a different taxpayer with similar facts.