Answering Questions Raised by IRS Authorization of 401(K) Contribution Student Loan Payments

In a recent Private Letter Ruling (PLR), the Internal Revenue Service (IRS) authorized making 401(k) plan contributions to participants who repay their student loans instead of contributing to the plan. (See related August story.)

The PLR opens the door to new opportunities for employers who:

• want to attract and retain employees with outstanding student loans; and
• have recognized that employees burdened by student loan debt may lack the funds to make 401(k) contributions and receive employer matching contributions.

However, the plan design in the PLR is somewhat atypical, and there remain legal and administrative questions about how such a program would operate in a plan with other features.

Details of the Program

The plan described in the PLR provides a flat 5-percent match for any participant who contributes at least 2 percent of compensation. It also provides a similar 5-percent employer contribution (referred to here as the “Student Loan Contribution”) in lieu of the match for any participant who makes student loan payments of at least 2 percent of compensation. If a participant who has signed up for the program makes both a 2-percent deferral and a 2-percent loan repayment, the participant will receive only the 5-percent Student Loan Contribution—not the 5-percent match.

It is important to note that, even though the Student Loan Contributions operate similarly to matching contributions, they are technically not matching contributions and are not subject to the actual contribution percentage (ACP) test. Instead, they are subject to separate discrimination testing, which requires they be made to a nondiscriminatory group of employees.

Legal Issue Addressed

The PLR addressed the “contingent benefit rule,” which provides that no benefit, other than a qualified plan match, can be based on an employee contributing to, or refraining from contributing to, a 401(k) plan. The IRS determined that the specific program in question did not violate the contingent benefit rule. However, it is not entirely clear whether the IRS would reach the same conclusion for other programs with slightly different features.

Plan Design Considerations

There are various legal and administrative issues to consider when designing such a Student Loan Contribution program. They include:

1. Because the Student Loan Contributions are subject to separate nondiscrimination testing (and not ACP testing), depending on the demographics of a given employee population and/or whether different rates of Student Loan Contributions are available under the plan, it may be necessary to limit the program to non-highly compensated employees (NHCEs).
2. It is not clear what type of documentation, if any, may be needed to verify that student loan repayments have been made. For example, it may be appropriate to rely on employee representations, but this is not clear. If documentation is necessary, there may be significant processing issues, especially for larger plans.
3. Any such processing issues will be compounded if Student Loan Contributions are made each payroll period. Because of this, it may be necessary to make the Student Loan Contributions annually even if the regular match is made each pay period. With annual contributions, the plan could impose a requirement that employees be employed on the last day of the plan year to qualify for the Student Loan Contributions.
4. In a safe harbor 401(k) plan, it may be necessary to make both the match and the Student Loan Contributions for a participant who makes both deferrals and student loan payments. The safe harbor rules require that the safe harbor match be made to all NHCEs, and the contingent benefit rule would not allow the Student Loan Contributions to be made only to employees who choose not to make deferrals. This requirement could make the student loan program prohibitively expensive.
5. It is possible that Student Loan Contributions would encourage participants to make student loan repayments instead of contributing to the 401(k) plan. In addition, Student Loan Contributions are not taken into account in the ACP test. Both of these could have an adverse impact on the plan’s annual actual deferral percentage (ADP)/ACP testing.
6. Finally, it is not clear what other types of behavior could be encouraged by plan contributions.  For example, could an employer encourage home ownership by making a similar program available to its employees who make mortgage payments?

Next Steps

For employers considering Student Loan Contributions, there are many details to consider and administrative issues to work out. Also, before any program is implemented that does not very closely track the PLR released in August, it may be worth requesting an individual ruling from the IRS.

Don A. Mazursky s the founder and managing member at Mazursky Constantine LLC in Atlanta. Mazursky Constantine is the largest firm in the Southeast specializing in employee benefits and executive compensation.