Linking Student Loan Repayments and 401(k) Plan Contributions

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.  

A recent call with a financial advisor in Colorado is representative of a common scenario involving participants with student loan debt. The advisor asked:  “I’m hearing more and more about 401(k) plans that allow participants to receive employer matching contributions based on their student loan payments. Is this permitted? What about the contingent benefit rule?” 

Highlights of the Discussion

According to the Federal Reserve, student loan debt has reached a staggering amount: $1.52 trillion. For many younger workers it has become a huge stumbling block to achieving financial wellness. A new in-plan approach to addressing student loan debt is to provide some kind of loan repayment incentive through the employer’s 401(k) plan. The industry has been hearing more and more about such arrangements, especially following an IRS private letter ruling (PLR) issued in 2018 to Abbott Laboratories and new proposed legislation in 2020. 

PLR 201833012 cracked open the door to encourage retirement savings by those saddled with student loan debt. In the method approved by the IRS in the PLR’s scenario, an employee with student loans was be able to enroll in his employer’s 401(k) plan, make monthly student loan payments to the loan servicer outside of the plan, and have his employer make “student loan repayment nonelective contributions” into the employee’s 401(k) retirement account that “matched” the participant’s loan payment, up to a certain amount.  Since the nonelective contribution was not contingent upon making employee salary deferrals, the plan did not violate the “contingent benefit” prohibition of Treasury Regulation §1.401(k)-1(e)(6).  The contingent benefit rule prohibits conditioning the receipt of other employer-provided benefits on whether an employee makes employee elective salary deferrals. Receiving matching contributions is the sole exception to this rule. The PLR did not address whether the plan meets other qualification requirements under IRC Sec. 401(a). 

A PLR may not be relied on as precedent by other taxpayers. Consequently, while the interest of plan sponsors is there to use their companies’ 401(k) plans to help employees reduce student loan debt and improve financial wellness, and a few companies have stuck their toes in the water, the general uncertainty of how the feature would affect a plan’s overall qualified status in the eyes of the IRS still hinders its widespread adoption.  

To help curb employer reticence, there is currently a proposal before Congress entitled the Securing a Strong Retirement Act of 2020 that includes Section 110: Treatment of student loan payments as elective deferrals for purposes of matching contributions. Under the bill, an employer would be permitted to make matching contributions under a 401(k) plan, 403(b) plan, or Savings Incentive Match Plan for Employees (SIMPLE) IRA plan with respect to “qualified student loan payments,” the definition of which is broadly defined as any indebtedness incurred by the employee solely to pay “qualified higher education expenses” of the employee. Similarly, governmental employers would also be permitted to make matching contributions in a 457(b) plan or another plan with respect to such loan repayments. This would essentially treat an employee’s student loan payment as an elective deferral. 

Regardless of what happens to SECURE Act 2.0, the IRS has made guidance on the connectivity of student loan payments and qualified retirement plans (including 403(b) plans) at top priority for 2021.1

Conclusion

Employers are focusing on employee financial wellness, including adopting measures to help alleviate student loan debt and encourage retirement savings. One enticing option that advances both goals, potentially, is linking student loan repayments with 401(k) plan contributions. The industry can anticipate more guidance in 2021—whether in the form of new Treasury Regulations or federal law.