Student Loan Debt Part II: The IRS Weighs In
On August 17, 2018, the Internal Revenue Service (IRS) publically released a private letter ruling[1] stating that employers wanting to help fund student loan repayment for their employees are able to do so without violating the contingent benefit prohibition in § 401(k) of the Internal Revenue Code. This seems to indicate a willingness from the IRS to consider other programs which would benefit employees’ efforts to repay student loan debt. As tax incentives are an important way to shape public policy, this signals the IRS is concerned for young professionals saddled with large student loan repayments.
As stated in Nauman Smith’s previous article written on the subject,[2] student loan debt is one of the largest financial burdens on younger employees. Many younger workers need to prioritize paying off student loan debt rather than saving for retirement at the beginnings of their careers. As such, offering assistance for student loan repayment as part of a benefits package makes employers more competitive in the hiring cycle and more attractive to young talent.
To accommodate a young employee’s decision to prioritize paying off debt, a company seeking to modify its original benefits program anonymously requested guidance from the IRS on whether its proposed program would violate the prohibition against contingent benefits under § 401(k). The contingent benefit prohibition does not allow employers to condition an employee’s 401(k) benefits on the employee having to make a choice between receiving cash or getting a 401(k) contribution. The § 401(k) prohibition does not apply, however, to an employer matching program where the employer matches an employee’s contributions for the year.
Originally, the company maintained a traditional 401(k) matching plan. If the employee made an elective contribution to his or her 401(k) program during the pay period of at least 2% of his or her eligible income, the company would make a matching contribution of 5% of the employee’s eligible income for that pay period to the employee’s 401(k). This was not violative of § 401(k).
The company sought to modify its existing program to include an option for student loan repayment benefits for its employees. Under the proposed plan, the employer would make a nonelective contribution on behalf on its employee conditioned on the employee making student loan payments. The plan would be voluntary and the employee could elect to opt in or out on a prospective basis. Should the employee choose to opt in, the employer would make either a student loan repayment nonelective contribution or a true-up matching contribution, depending on the nature of the employee’s contribution during the pay period.
For instance, if the employee made a contribution of at least 2% of his or her eligible compensation toward student loan repayment, then the company would make a corresponding student loan repayment contribution “as soon as practicable after the end of the year” of 5% of the employee’s eligible compensation for that pay period. In contrast, if an employee did not make a student loan payment of at least 2% of his or her eligible compensation, but did contribute at least 2% of the eligible compensation to his or her 401(k) program, then the company would make a matching contribution of 5% of the employee’s eligible income to the employee’s 401(k) plan.
Here, the IRS informed the company that because student loan repayment nonelective contributions under the proposed program are conditioned on whether an employee makes a student loan payment during a pay period, rather than on the employee making elective contributions under a cash or deferred arrangement, the program would not violate § 401(k)’s contingent benefit prohibition. The hallmark of this program was that the employer would still make matching contributions to an employee’s 401(k) even if the employee failed to make the requisite 2% contribution to student loans. Programs making 401(k) contributions contingent on student loan repayment may not be as successful for tax purposes since they would violate the prohibition on contingent benefits. The IRS also cautioned that the company’s proposed program would be unlawful if it began making student loans to its employees.
This is promising news for employers who may be considering starting similar programs to entice younger talent. Currently, Aetna, Penguin Random House Publishing, Fidelity Investments, and Natixis, among others are some companies already offering student loan repayment benefits. While the IRS’s letter is not binding, it does indicate a willingness to cooperate with employers offering similar benefit programs to their employees. Businesses looking to implement a student loan repayment assistance program may want to consider a model similar to that in the IRS’s letter since it has passed the first informal IRS test.
This article was written with contribution from Sarah Rothermel, 3rd year law student at Widener Law Commonwealth.
[1] Found at: https://www.irs.gov/pub/irs-wd/201833012.pdf
[2] Found at: https://www.nssh.com/2018/08/student-loan-debt-a-new-way-to-attract-top-talent/