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By Michael A. Webb
Student loan debt is one of the main reasons why millennials do not save for retirement at a time when saving for retirement is critical, due to the time value of money. In response to this dilemma, Abbott Labs has implemented a program that allows participants to continue to receive employer matching contributions, provided they repay their loans at the same level as they had been deferring their own money into the plan. In other words, Abbott Labs retirement plan now matches student loan repayments!
As a result, people who could not afford to make their student loan repayments and simultaneously defer into their retirement plan now only need to make the loan repayments that they were likely making anyway (unless they are contributing less than the 2 percent of pay that was required here to receive the employer contribution, in which case they would need to bump up their student loan repayment to that amount) in order to receive an employer contribution to their Section 401(k) plan. If Abbott Labs could proceed with such a program, it would be a fantastic and groundbreaking development in the world of retirement plan design.
However, due to Internal Revenue Service restrictions as to the types of benefit that can be conditioned on contributions to a retirement plan (the so-called “contingent benefit rule”), it was uncertain whether Abbott Labs could do what they wished to do. Thus, they requested (or at least we believe they requested, since the process is confidential) a PLR from the IRS to determine if they could, in fact, implement this program without breaking any IRS rules. Fortunately, PLR 201833012 said that they could in an uncharacteristically brief (four-page) ruling.
Specifically, the program the IRS approved contains the following features:
If the employee makes a student loan repayment equal to at least 2 percent of compensation in a pay period, the employer will make a 5 percent-of-pay nonelective contribution to the Section 401(k) plan for that pay period on the employee’s behalf.
Alternatively, if an employee does not make a student loan repayment of at least 2 percent, he/she can still make an elective deferral to the Section 401(k) plan of at least 2 percent and receive an employer matching contribution of 5 percent of pay, again on a per-pay period basis.
However, an employee cannot receive BOTH employer contributions; if an employee makes the 2 percent loan repayment, he/she can make elective deferrals to the Section 401(k), but will not receive the additional 5 percent match, just the 5 percent nonelective contribution.
The student loan repayment program is voluntary. An employee must elect to enroll in the program and may also later opt out from future student loan repayments if he/she wishes. As soon as the employee opts out of the program, he/she resumes eligibility to receive the 5 percent employer matching contribution if he/she defers at least 2 percent to the 401(k).
The employee must be employed on the last day of the plan year to receive either the 5 percent nonelective contribution or the 5 percent matching contribution. In order to enforce this provision, though the employer contribution is credited on a per-pay period basis, the nonelective contribution/match is not actually remitted to a participant’s account until after the close of the plan year.
The 5 percent nonelective contribution is subject to the same vesting schedule as the 5 percent matching contribution.
The 5 percent nonelective contribution, unlike the 5 percent matching contribution will NOT be treated as a matching contribution for Section 401(m) actual contribution percentage (ACP) testing purposes, even though the student loan repayment is essentially being “matched” in the retirement plan. This makes it easier to implement such a program, because the plan sponsor does not have to worry about the demographics of the people who choose to participate causing an ACP test failure (but see below regarding other testing issues).
The plan sponsor affirmed that it will NOT be extending any student loans to employees in the program. (I don’t know why the IRS felt the need to obtain this affirmation, since the plan sponsor in question is most certainly not in the student loan business, but they did.)
The approval of such a program, as other commentators have pointed out, certainly opens the door to other entities sponsoring similar programs.
Well, first of all, the PLR applies to only Abbott Labs (or whomever requested it if it was not Abbott Labs). Thus, it might not be the best idea for plan sponsors to implement their own plans unless they request their own PLR, which is not one of the easiest of things to do. So, until potential future IRS guidance is issued that would apply more broadly, the practical application of this ruling to other employers is limited.
There are a number of practical issues with the guidance. First, someone must monitor all the loan repayments to ensure that they amount to at least 2 percent of compensation each pay period, as well as when repayments cease (such as when a loan is paid off, deferred, or forgiven) or resume (such as when a deferment ends). The retirement plan recordkeeper is unlikely to have the ability to monitor loan repayments, because they occur outside of the retirement plan; similarly, the plan sponsor is not likely in a good position to monitor such repayments, either. Thus, a third party would need to be hired to provide this service; and because this service is brand new, there might be some hiccups as a service provider (likely one who provides general student loan repayment assistance to employees) learns the ropes of such a new process. Payroll data would also need to be provided to any service provider who is tracking loan repayments, which is likely to be a cumbersome process.
Second, because the employer is not the lender, it will also presumably need to collect proof of loan repayments from all loan providers to employees, which can be numerous, and no doubt this will be a burdensome process (and the PLR does not specify the degree to which loan repayments will need to be verified).
Third, because employees must enroll in the program, and can also opt out, again someone will have to enroll employees and track opt-outs. However, this service is more likely to be able to be provided by the retirement plan recordkeeper.
Fourth, under such a program, there will likely be fewer employees making elective deferrals to the retirement plan, in favor of making student loan repayments. If such employees are disproportionately non-highly compensated employees (NHCEs), this could negatively impact Section 401(k) average deferral percentage (ADP) testing, which is dependent upon such employees making elective deferrals to the plan.
There are two disadvantages to participants in such a program when compared to traditional elective deferrals to a retirement program. Unlike elective deferrals to a Section 401(k) plan, loan repayments are made from after-tax funds. Thus, the employee will need to contribute more of his/her net take-home pay to make a 2 percent loan repayment than he/she would to make a 2 percent elective deferral to the Section 401(k).
If the employee makes loan repayments in lieu of elective deferrals to the Section 401(k) plan, less total contributions will go into the Section 401(k), resulting in less retirement wealth accumulation over time.
Having said all of this, a “match” of loan repayments into a Section 401(k) plan compares quite favorably to other options for employers to assist employees with student loan repayments.
Instead of the program described above, an employer can provide direct financial loan repayment assistance to an employee, in either the form of a direct cash payment (e.g., $50 per month directly toward the employee’s student loan) or by matching a loan repayment with an additional amount (e.g., if the employee makes a $50 loan repayment, the employer matches it with an additional $50 loan repayment). However, because there is no tax-favored vehicle in which to provide such assistance, any cash provided by the employer for loan repayment assistance is taxable to the employee. That is in contrast to the Section 401(k) program described above, where the employer “match” is not taxable to the employee and is also deductible by the employer.
An employer could also provide a student loan debt management program to employees that would offer favorable refinancing and other solutions to an employee’s student debt problems. In fact, there are several start-up companies out there that specialize in these types of services. However, unlike the programs described above, the employer would only be providing program access and not a direct subsidy to employees, so the value of such a program may be less apparent to an employee.
One thing is clear, however: it is likely that student loan repayment assistance programs, whether provided within or outside of a Section 401(k) plan structure, are a benefit that is likely to grow in popularity in the coming years as the student loan debt problem becomes more and more pervasive.
Mike Webb has been a member of Cammack Retirement since 1991. For over 25 years, he has provided retirement plan operational compliance consulting services for tax-exempt industries, including healthcare, colleges and universities, cultural institutions, and social service entities.
Mike is a nationally recognized subject matter expert on non-profit retirement plan fiduciary issues and a frequent writer and speaker in this area.
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