IRS Rules Favorably on 401(k) Contributions That Reward Student Loan Payments

The IRS has issued a favorable private letter ruling on an employer’s proposal to reward student loan repayments with nonelective contributions to a 401(k) plan. The employer’s 401(k) plan currently provides a 5% matching contribution for elective contributions (i.e., elective deferrals, designated Roth contributions, or after-tax contributions) of at least 2% of eligible compensation. Those matching contributions are made each payroll period. Under the proposal, employees enrolled in the program would give up their right to the plan’s regular matching contribution, and receive instead a 5% nonelective contribution for any pay period in which they made student loan repayments equal to at least 2% of their eligible compensation, regardless of whether they made any elective contributions. For any pay period in which they did not make a sufficient student loan payment to earn the nonelective contribution, enrolled employees would still get a 5% matching contribution if they made elective contributions of at least 2%. But those “true-up” matching contributions, as well as the nonelective contributions earned by making student loan payments, would be paid at the end of the year and would be contingent on being an employee at year-end (subject to exceptions for death or disability). The employer submitting the request specifically asked the IRS whether the proposed amendment would run afoul of the “contingent benefit” prohibition in the Code and regulations, which prohibits plans from making benefits (other than permitted matching contributions) contingent on electing to make or not make elective contributions.

The letter ruling observes that while the 5% nonelective contributions for enrolled employees are conditioned on whether they make a sufficient student loan repayment, they are not directly or indirectly conditioned on the making of elective contributions under the plan because employees do not have to stop making elective contributions to obtain the student loan repayment benefit. Consequently, the contingent benefit rule will not be violated by the proposed amendment. The ruling states that it is based on the assumption that the employer will not extend any student loans to employees who will be eligible for the program.

EBIA Comment: This ruling showcases a novel approach to the problem of student debt that will allow this employer to reward its employees for reducing their student debt without substantially increasing the employer’s costs, apart from administration and any increased utilization. And cash-strapped employees who can’t afford to pay their student debt and make elective contributions will be able to grow their 401(k) account balances and reduce their student debt at the same time by redirecting their funds from contributions to student loan payments. Freed of concern that its proposal will violate the contingent benefit rule, this employer will still need to navigate a variety of practical issues, including the substantiation of student debt amounts and employees’ loan payments. Other employers wishing to emulate this approach may take comfort from this ruling, but should keep in mind that the ruling is limited to its facts, and that IRS private letter rulings apply to and protect only the taxpayers that request them. Also, this design may not work in other circumstances (e.g., for plans that use design-based safe harbors that require all employees to receive prescribed minimum contributions). For more information, see EBIA’s 401(k) Plans manual at Sections VIII.K (“Contingent Benefit Rule”), IX.B.2 (“Matching Contributions Are Exception to Contingent Benefit Rule”), and XXII (“Nondiscrimination: ADP and ACP Safe Harbor Plan Designs”).

Contributing Editors: EBIA Staff.