Paying Paul without Robbing Peter: A Tax-Friendly Way for Employers to Fund Student-Loan Obligated Employees’ 401(k) Plans

Meet Paul, full of possibilities - retirement savings.  Meet Peter, the bane to the existence of many – student loan debt.   

Imagine that after providing the minimal essentials in the way of caring for yourself - and possibly your family - you lack sufficient funds to fully pay both Peter and Paul (don’t worry about Mary, she got her money already). If you only pay Peter, what happens with Paul? Do you dodge Peter and end up with numerous financial issues, including compounded interest owed Peter, in hopes to obtain a greater chance of stability in retirement, or even a greater chance to retire at all, by paying Paul?   

As student debt figures reach further into the trillions, many employees - young, and not so young – continue to wrestle with the stress of paying off student loan repayment obligations. Whether it’s the need to delay purchasing a home, creating or expanding a family, or even retiring, those saddled with student loan debt often find themselves in a situation where they have to rob Peter to pay Paul.

Student loan debt relief as an employee benefit is being predicted by many in the financial industry as the next big thing in retirement. Companies like Abbot Industries and others are leading the way.

Enter PLR 201833012 (August 17, 2018) – hope and a chance. In this recent broadly-noticed IRS private letter ruling, one student loan repayment program model allows for employees who pay a minimum of 2% of their pay towards student loan debt to earn an employer nonelective contribution of 5% of their pay to the employee’s 401(k) plan. Under the contingent benefit rule (§401(k)(4)(A)), an employer may not base its decision to contribute to an employee’s 401(k) account on the amount or percentage of an employee’s own contributions to his/her 401(k) account, except in the case of matching contributions. The IRS confirmed that the company seeking to include this type of student loan repayment assistance benefit in its 401(k) plan could do so without violating the contingent benefit rule. As such, the employer may pay into an employee’s 401(k) plan while the employee pays off student loan debt, even if the employee does not choose to make salary deferrals to his/her 401(k) plan.

Although this PLR has no precedential effect, there is value in the confidence it can give employers seeking to offer similar programs in order to attract education-debt-laden-but-good job candidates. Not only did this letter ruling highlight a student loan repayment benefit method that had not yet received widespread attention, it may also lead to more concrete IRS guidance that taxpayers can rely on, and increase the availability of safe harbor and preapproved plan offerings with similar features. Plan sponsors must remember to ensure compliance with existing qualified plan rules in order to maintain tax-favored status, including making sure their written plan document satisfies nondiscrimination requirements. Until more guidance exists, employers would need to seek their own private letter ruling – an expensive and time-consuming process, take advantage of a preapproved plan with a favorable ruling in place, take a chance with setting up a plan on their own, or wait.

Praising the IRS for the ruling, the ERISA Industry Committee has also requested broader guidance from the IRS in the form of a revenue ruling, which could be relied upon by companies other than Abbott Industries (since confirmed as the company for whom the PLR was issued).

This feature is an incredible benefit to employees with school loans who have not been able to prepare or save for retirement, especially at a time where the traditional “three-legged stool” of retirement – personal savings, social security, and a pension/retirement plan – has taken some hits and become less sturdy than before.

More could be done, i.e. Congressional action, to tackle the massive student loan debt issue at its foundation outside of employers helping employees to focus on paying off student loan debt (which may also be a boon to education loan lenders) while facilitating a way for employees to still accumulate some sort of funds towards retirement. For now, this PLR highlights something employers can and are beginning to do now – invite employees to pay Peter, while the employers pay Paul.