Student Loans and 401(k) Plans - A Promising and Challenging New IRS Ruling

One thing is clear from my admittedly antidotal experience working with employers and studies over the years: employees burdened with student loans contribute less to their 401(k) plans than those who don’t. But you have more than my experience to go on. As reported in a Forbes article,the Employee Benefit Research Institute (EBRI) found that “401(k) workplace retirement plan balances are lower for those with student loan debt than for those without it.” EBRI said this is a direct threat to retirement income security with approximately 26% of families having student loan debt and among households with a head 35 or younger, nearly half having student loans.

“According to the Employee Benefit Research Institute (EBRI), families ages 45 to 54 without student loans have a median 401(k) balance of $80,000 versus just $46,000 for those with student loans. Families with heads younger than 35 without student loans have a median $11,000 401(k) balance versus $8,000 balance for those with student loans.”

In a recently issued private letter ruling the IRS approved an arrangement designed to boost 401(k) contributions for participants burdened with student debt in a roughly cost neutral manner. Although the letter leaves open many questions, it offers significant potential for employers looking for ways to deal with the problem of student debt and diminished or non-existent contributions by employees who are so indebted.

This is how the arrangement is described in the private letter ruling (PLR):

• The employer agrees to make contributions (called “student loan repayment contributions” or “SLRC”) to the plan that are linked to the participant’s student loan debt repayments.

• Participation in the student loan payment contributions is completely voluntary

• The contributions will be made for each pay period the employee makes a student loan payment that equals or exceeds 2% of the employee’s compensation

• The contributions will be made only if the employee is employed on the last day of the year

• The amount of the contribution is equal to 5% of the employee’s compensation for the pay period.

• The SLR contributions are in place of regular qualified non-elective contributions or “QNECs” the employer makes to employees who make elective salary deferral contributions to the plan, although a participating employee is allowed to make salary deferral contributions without losing eligibility for the program.

• The IRS assumed the employer will not extend any student loans to employees that will be eligible for the program.

Example: XYZ, Inc. maintains a 401(k) plan for its employees. The plan provides that XYZ will make a 3% qualified non-elective contribution (QNEC) to eligible employees. Effective January 1, 2019, XYZ amends the plan to provide for a 5% SLRC for eligible employees under the formula described above, who voluntarily elect not to take the QNEC and who are employed by XYZ on the last day of the year. Sam is a 30-year old employee of XYZ and a participant in the plan. He earns $72,000 per year and makes student loan payments of $600 per month. In April 2019 Sam voluntarily elects to take student loan repayment contributions and acknowledges that he will not receive a QNEC. He continues his salary deferral contributions of $5,000 on annual basis. Provided he stays employed through December 31, 2019 his contributions for the year on a monthly compensation period, monthly basis will look like this:

The above grid roughly illustrates the outcome for one participant based on the plan design in the PLR. There may be other designs just as acceptable to the IRS. Also, as mentioned the PLR leaves a number of issues hanging that I imagine the company receiving it have resolved and that an employer seeking to use their approach or one similar to it would have to address too. For example:

· What is the impact of the arrangement on discrimination testing? Might there be testing failures if, say, highly compensated are benefiting more greatly than non-highly compensated? How can those be prevented?

· What level of substantiation/monitoring should the employer require to assure itself monthly loan payments are being made? How much will this burden the employer and can processes be devised to lessen it?

· Will offering such a program cause resentment among employees who are not receiving this additional benefit. If so, how can the challenge be best addressed?

I’ve only scratched the surface with this short list. Also, the PLR can only serve as a rough guide for other employers seeking to have an arrangement that copycats the PLR or that departs from it, based on the particular employer’s own specifics and goals. Nevertheless, the PLR presents interesting opportunities for employers who want to help student-debt-burdened employees save for retirement, even if “caution” is the key word they should keep in mind as they go forward.

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Chuck Humphrey focuses is practice on employee benefits and is the principal of Law Offices of Charles G. Humphrey, Buffalo, New York, a consultant to Fiduciary Plan Governance, LLC, and the author of The Fiduciary Responsibility eSource, available at ERISApedia.com.