IRS Allows 401(k) Match for Student Loan Repayments

updated on September 5, 2018

A new IRS ruling approves an employer's plan to help workers save for retirement while paying off student loans.

On Aug. 17, the IRS made public its Private Letter Ruling (PLR) 201833012, which was issued to the requesting company on May 22. The letter responds to an unnamed employer that proposed amending its 401(k) plan to offer a student-loan benefit program under which it would make special 401(k) contributions into the accounts of employees who are making student loan repayments.

Earlier this year, Abbott Laboratories launched such a benefit. At Abbott, a research and development company based in Lake Bluff, Ill., full- and part-time employees who qualify for the company's 401(k) and contribute 2 percent of their eligible pay toward their student loans through payroll deductions receive an employer match equal to 5 percent of their pay deposited into their 401(k)s—the same percentage match Abbott gives to employees who contribute at least 2 percent of their pay to their 401(k)s. 

Program recipients receive the match without being required to make any 401(k) contributions of their own, allowing them to use more of their earnings to pay off student debt. "The benefit responds to recent financial challenges facing young employees … and adds to the strong appeal of joining the Abbott family," the company stated in a July news release.

When adopting this approach to student loan repayment aid, Abbott signaled that the benefit was starting to go mainstream, despite a lack of IRS guidance. But Abbott wasn't the first employer to offer this benefit. Prudential Retirement, a provider of 401(k) plan administration services, began doing so in 2016.

"As student loan debt grows, workers are having to choose between paying off their student loans or prioritizing other important financial goals," said Jamie McInnes, senior vice president and head of total retirement solutions for Prudential Retirement, when announcing the benefit. "Our research tells us many workers will choose to pay down debt rather than save for retirement."

A Tax-Free Benefit

Unlike student loan repayment (SLR) dollars given directly to employees, which are treated as taxable income, employer 401(k) contributions are not taxable. As a result, this approach achieves tax advantages like those associated with traditional tuition-reimbursement benefits but generally denied to student loan repayment benefits. A lingering question, however, has been whether this is legal.

A lingering question has been whether this is legal.

The Society for Human Resource Management supports bipartisan measures now before Congress that would make employers' loan-repayment aid a tax-free benefit treated the same as tuition assistance under Section 127 of the Internal Revenue Code and would increase allowable tax-free tuition assistance.

Contingent Benefits Prohibition

The IRS ruling addressed a major employer concern by stating that the proposal to provide student loan repayments through an employer's contributions to the 401(k) accounts of employees who are repaying student loans "would not violate the 'contingent benefit' prohibition of section 401(k)(4)(A) and section 1.401(k)-1(e)(6)" of the tax code.

The ruling "is helpful guidance in that it addresses a key concern—the contingent benefit rule—that is typically raised when structuring student loan repayment programs within or tied to a qualified plan," said attorney Elizabeth Thomas Dold, a principal with Groom Law Group in Washington, D.C., which posted an overview of the ruling.

Under the contingent benefits rule, "an employer may not make other benefits, such as health insurance, stock options, or similar entitlements, contingent on a participant's making elective deferrals under a 401(k) plan," wrote Christine Roberts, an attorney with Mullen & Henzell LLP in Santa Barbara, Calif.

The ruling held that because the employer's 401(k) contributions are triggered by employees' student loan repayments, "the IRS concluded that they did not violate the contingent benefit rule," Roberts explained.

While the amount of the special employer loan contribution is not linked to or otherwise affected by the employee's 401(k) contributions, Dold noted, "the regular match that an employee would otherwise be entitled to receive is reduced if the employer is making student loan repayments into the account."

She also noted that "this design will not work if the plan sponsor is actually providing the student loans that are being repaid, and unlikely to extend to safe harbor 401(k) plans."

[SHRM members-only toolkit: Designing and Managing Educational Assistance Programs]

The Ruling's Limited Scope

An IRS ruling is directed only to the employer requesting it and may not be cited as precedent, although it does suggest how the IRS may approach this matter in future guidance.

"Although the ruling is technically limited only to the taxpayer that requested the ruling—likely Abbott Labs—it is instructive to other plan sponsors who are interested in implementing similar designs to address this very apparent need to get student debt under control," Dold said.

The ruling "provides welcome confirmation that such an arrangement is permissible under certain circumstances," noted Jeffrey Holdvogt and Sarah Engle, partners in the Chicago office of McDermott, Will and Emery.

"A 401(k) student-loan match might not work with a safe-harbor 401(k) plan," said Norma Sharara, a principle with Mercer. "There are a lot of traps for the unwary."

A Cost-Effective Approach

In the case the IRS addressed, the employer's 401(k) contributions take the place of matching contributions that would otherwise be made to the plan if the employees had contributed to their 401(k) accounts themselves. As a result, this approach to student loan repayment aid "is also arguably closer to cost-neutral than most other student loan benefit programs," Holdvogt and Engle pointed out.

Traditionally, they noted, student loan reimbursement payments "result in an additional cost for the employer because the employer is adding a new benefit that requires paying an additional amount to employees in the form of the student loan benefit." However, under the program described in the ruling, the employer contribution offsets any matching contribution an employee would otherwise be eligible to receive under the plan. "This means that, unlike other types of student loan benefits, employers may be able to add a student-loan-repayment-based [contribution] to their existing retirement plan without considerable additional costs," Holdvogt and Engle noted.

A point to keep in mind, however, is that employees' student loan payments are made on an after-tax basis, and so "student loan repayments will, in effect, 'cost more' (to the participant) than regular 401(k) contributions," noted October Three Consulting, a retirement plan advisory firm, in an online post.

Issues to Consider

Notably, the ruling "does not address any of the other finer details of the Internal Revenue Code that must be considered with such a arrangement," such as how the benefit might interact with 401(k) plan eligibility, vesting, and distribution rules, and annual coverage and nondiscrimination testing to ensure that the 401(k) plan does not favor highly compensated employees, Dold said.

"Participant student loan repayments will not count toward actual deferral percentage (ADP) testing and the related employer nonelective contributions will not count towards actual contribution percentage (ACP) testing," observed October Three Consulting. The fact that generally nonhighly compensated employees are making student loan repayments rather than 401(k) elective contributions "may negatively affect ADP or ACP testing results, reducing the amount that could be contributed by or for highly compensated employees."

"The employer will need to work closely with its recordkeeper to determine how an SLR program may be structured without causing the plan to fail coverage and nondiscrimination requirements," wrote B. David Joffe and Caleb Barron, attorneys in the Nashville office of law firm Bradley. For example, problems could arise if 401(k) contributions under the program "would seem likely to result in lower elective contributions and lower regular matching contributions being made for non-highly compensated employees," they pointed out.

Also, "the employer’s 401(k) plan will need to be amended to provide for the program," they noted.

What's Next

Despite these challenges, vendors that help employers contribute toward student loan repayments "will probably move to establish and market versions of the SLR nonelective contribution program described in the private letter ruling, in which case additional, and more broadly applicable, IRS guidance would be welcome," Roberts said.

To that end, the ERISA Industry Committee (ERIC), which advocates on behalf of large employers, on Aug. 29 sent the IRS a letter asking that it broaden the reach of PLR 201833012 to enable all sponsors of 401(k) plans to make similar contributions that offset employees' student-loan repayments.

"The recently issued PLR is a significant step in right direction, but ERIC believes that more employers would be encouraged to implement retirement savings programs to assist individuals who are repaying student loans, similar to the one described in the PLR, if the IRS would issue a revenue ruling or other guidance of general applicability on this issue," wrote Will Hansen, ERIC's senior vice president of retirement and compensation policy.

Until the IRS issues expanded guidance, employers wishing to put such a program in place "should consult legal counsel to assess potential liability," Roberts advised.