Lowell J. Walters of Carlton Fields Jorden, Burt.

With U.S. student loan debt totaling $1.5 trillion, employers are seeking ways to ease the burden of repayment for their employees and prospective employees. These have included signing bonuses and direct repayment of outstanding loans. Now, employers appear able to make matching-type contributions to retirement plans based on student loan repayments instead of on salary deferrals alone. On Aug. 17, the IRS publicly released a private letter ruling, allowing an employer to make a matching contribution to its 401(k) plan based on student loan repayments.

Background

In general, matching contributions allow an employer to make a contribution to its retirement plan if (and only if) the employee voluntarily chooses to salary defer into that plan. Employees who defer less than the amount necessary to receive the maximum match are often warned that they are losing out on potential returns and income. Yet responsible employees with student loans must honor their repayment requirements before deferring anything to their company's retirement plan.

Student Loan Repayments

In IRS Private Letter Ruling 201833012 (PLR), the employer made matching contributions to any employees who salary deferred at least 2 percent. The IRS approved the expansion of this opportunity to include any employee who met that requirement or made student loan repayments in amounts that were at least equal to 2 percent of their compensations. Technically, those who met the 2 percent threshold with salary deferrals received a “matching contribution” while those who satisfied the threshold with student loan repayments would receive a “nonelective contribution.” Employees interested in receiving the contribution triggered by student loan repayments were required to opt out of eligibility for the match so they would not receive double contributions. The IRS confirmed that employers may make employer contributions based on student loan repayments without violating the prohibition against basing employer contributions (other than matching contributions) on salary deferrals (known as the “contingent benefit rule”).

Warnings

The employer who received the PLR did not propose to combine the level of salary deferrals and student loan repayments to determine eligibility for the employer contributions. For example, it did not seek to provide its contributions to employees whose salary deferrals and loan repayments, combined, met the 2 percent threshold. That means that employees with loan repayments of under 2 percent would not receive the employer contribution unless they also salary deferred at least 2 percent to the plan. This limit may be meant to foster administrative convenience, or it may have resulted from negotiations with the IRS. The IRS also stated that its ruling assumes that if the employer issues student loans, repayments of those loans will not count toward satisfying the 2 percent threshold.

Furthermore, while the ruling addressed a specific question relating to 401(k) requirements, it did not address numerous nondiscrimination issues. It is rare for a plan to allow participants to “opt out” of a matching contribution, so it would have been helpful for the IRS to outline the issues raised. For example, IRC section 401(a)(4) requires plan features to be equally available to all participants. How might opting out of the matching contribution affect this feature's compliance with that requirement? How do we assess which employees are eligible to use the student loan contribution feature? Does the restriction to employees whose student loan repayments total 2 percent of compensation focus on the required monthly payment, or can employees with lower payments participate if they make additional, advanced repayments?

If the individuals with student loans are newer, nonhighly-compensated employees, the contribution should not be viewed as discriminatory. However, this kind of structure could hurt a company's actual deferral percentage (ADP) test results. The ADP test compares the salary deferral rates of highly-compensated employees to nonhighly-compensated employees. Often, a matching contribution is used to encourage salary deferrals. However, the employer who received the PLR at issue eliminated this incentive for employees who will automatically receive an employer contribution because they pay 2 percent or more of their compensation toward student loans. With no further incentive to salary defer, this group is more likely to reduce or cease their deferrals. That decision to stop or reduce salary deferrals could result in a reduction of the deferral rate for nonhighly-compensated employees, increasing the likelihood of failing the ADP test. Of course, this would not be a concern for 403(b) plans that must satisfy “universal availability” requirements instead of the ADP test, or governmental 457(b) plans which are exempt from nondiscrimination requirements.

Takeaways

The key takeaway is that the IRS looked favorably at an employer's attempt to provide retirement benefits to employees who might have been unable to defer because of student loans. This should give some level of comfort to other employers who want to develop similar programs. Some readers may wonder why this employer did not simply offer an education assistance program that allowed employers to reimburse employees for education expenses. The concept implemented by this employer may have been more attractive than an education assistance program because education assistance programs only allow reimbursements of education expenses incurred while the individual was employed with the company, while the retirement contribution is based on the repayment of a loan that could have been incurred prior to employment.

Lowell Walters is a shareholder with Carlton Fields in Tampa.