The IRS released a private letter ruling on August 17, 2018, in which it approved a student loan repayment benefit that was connected to an employer’s contributions to its 401(k) plan. Though the IRS’s ruling applies only to the applicant taxpayer, it presents an intriguing planning opportunity for employers.

It’s clear from commentary that student loan debt has increased dramatically in the last decade, and employers concerned with the resulting financial burden on their employees—and their low level of retirement savings—are experimenting with student loan benefits. Examples include signing bonuses, reimbursing employees for loan payments and paying loans directly. But most of these programs result in employees receiving taxable income equal to the benefit. In response, some employers have considered 401(k) plan programs that are specifically designed to benefit employees who make student loan payments.

However, the tax qualification rules for 401(k) plans have generally been viewed as problematic. In particular, under the “contingent benefit rule,” employers may not condition an employee’s receipt of “other benefits” on making 401(k) contributions. The IRS defines “other benefits” to include life, dental and health benefits, stock options and most compensation. Also included in this definition are an employer’s contributions to a 401(k) plan.

The IRS determined that the 401(k) plan and student loan repayment program described in the private letter ruling would avoid violating the contingent benefit rule, based on the following design:

• The 401(k) plan will provide for a regular employer matching contribution equal to 5% of employee compensation for each pay period that the employee makes an elective contribution of at least 2% of the employee’s compensation. If the employee doesn’t elect to participate in the student loan repayment program, the employee will continue receiving this match.
• If an employee elects to participate in the program, for every pay period in which the employee makes loan payments equal to at least 2% of compensation, the employer will make a nonelective contribution of 5% of the employee’s compensation for that period. The nonelective contribution will be made at the end of the plan year, but only if the employee was employed on the last day of the year (unless they terminated employment earlier due to death or disability).
• An employee may elect out of the program at any time. And if a participating employee does not make a qualifying student loan payment during a pay period, but makes an elective contribution to the 401(k) plan of at least 2% of the employee’s compensation, the employer will make a “true up” nonelective matching contribution of 5% of the employee’s compensation for that period, subject to the same last-day-of-the-year condition described above.
• The employer’s nonelective matching contributions will be subject to the same coverage, nondiscrimination testing and other requirements for tax-qualified retirement programs, including annual contribution limits and eligibility, vesting and distribution rules. And the plan sponsor will not extend any student loans to employees who are eligible for the program.

Three specific features were key to the IRS finding that the proposed 401(k) plan design will not violate the contingent benefit rule:

1. The employer’s nonelective contributions will not be conditioned on employees making (or not making) elective contributions to the plan;
2. Because employees can make elective contributions in addition to making student loan repayments, the employer’s nonelective contributions will not be contingent on employees electing to make (or not make) elective contributions in lieu of receiving cash; and
3. The employer will not extend any student loans to employees who are eligible for the student loan repayment program.

Following the date of the IRS’s letter ruling, Abbott Laboratories announced in June its “Freedom 2 Save” program, which appears to mirror the anonymous employer’s program described in the ruling. Even so, a number of open questions remain about how (and whether) to implement a program like the one described in the ruling, such as how to verify student loan repayments and what effect the program would have on other tax qualification requirements.

Recent conversations indicate a renewed interest in student loan repayment programs, particularly among employers who sponsor retirement plans. The IRS’s ruling provides only limited guidance, and it fails to address how such programs comport with technical plan qualification requirements other than the contingent benefit rule. Plan sponsors interested in adopting a student loan repayment program should consult with experienced employee benefits counsel.

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