Paying Off Student Loans and Building 401(k)s: IRS Suggests Workers Can Do Both

Tuesday October 2nd, 2018

Recent statistics show that 44 million Americans have student loan debt, totaling $1.4 trillion. This financial burden prevents people from making other investments—including saving for retirement.

Can employers help? There are few who do, even though repayment plans could attract job seekers who are burdened with student loan debt. However, this may change following an Aug. 17 IRS private letter ruling that approved an employer’s benefit plan that ties employees’ 401(k) contributions to student loan repayments.

IRS private letter rulings are not meant to be treated as a legal precedent. But this one in particular has caught the attention of employers and workers, because it may alleviate employers’ compliance concerns about offering student loan repayment benefits through qualified 401(k) plans.

In the situation covered by this ruling, certain employees are currently not contributing to the company’s 401(k) plan because they’re making student loan payments instead. As a result, the employees are getting no matching contributions from the employer either.

The ruling permits the employer, under certain circumstances, to link the amount of 401(k) contributions made on an employee’s behalf to the amount of student loan repayments made by the employee outside the plan.

Here’s how it would work. For each payroll period in which the participating employee makes a “sufficient” student loan payment, that employee would be eligible to receive a “non-elective contribution” to their 401(k) plan from the employer.

A student loan payment would be considered “sufficient” when the amount is equal to 2% or more of eligible compensation during a pay period in which the employee would have received a matching employer contribution. The “non-elective contribution” amount would be equal to the matching contribution the employee would otherwise receive if the employee made pretax, Roth 401(k), and/or after-tax contributions in the same payroll period.

The IRS based its decision to approve the student loan repayment plan on specific facts:

  • Participation in the plan is voluntary.
  • The student loan repayment benefit replaces the employer’s matching contribution; employees are not eligible to receive regular matching 401(k) contributions while participating in the program.
  • The repayment benefits are subject to coverage and nondiscrimination testing and requirements for qualified retirement plans apply, including contribution limits, eligibility, vesting, and distribution rules.
  • The IRS determined that the employer’s program does not violate the “contingent benefit rule” under Treasury regulations, which generally prohibits employers from making benefits conditional upon participant elective deferral contributions to a qualified cash or deferred arrangement under a 401(k) plan.

It’s also important to note that the employees participating are making loan payments to a lender—the employer’s plan does not provide student loans to employees.

This article was tagged with: benefits, IRS, 401(k), student loans, student loan