INSIGHT: What’s Next for Section 401(k) Contributions on Student Loans?

New graduates leave college and start their careers with a shiny diploma, a fresh outlook, and—on average—$29,800 in debt.

Add a Master of Science degree and the debt increases to $50,400. With that amount of debt, how is a new graduate to think about saving for retirement?

In fact, many new employees do not have enough disposable income to make deferrals to their tax code Section 401(k) plans. Instead, they focus on paying down loans, missing out on employer matching contributions and the benefits of compounding interest that will grow into their nest egg for retirement 45 years later.

Abbott Laboratories, a research and development company based in Lake Bluff, Ill., attempted to solve this catch-22 by offering a 5 percent nonelective contribution to any eligible employee who pays at least 2 percent of his or her pay toward student loans. “The benefit responds to recent financial challenges facing young employees … and adds to the strong appeal of joining the Abbott family,” the company stated in a June 2018 news release.

While the Internal Revenue Service will not confirm the name of the taxpayer, the Chicago Tribune reported that Abbott Laboratories was the company seeking a private letter ruling for the plan design described above. On Aug 17, 2018, the IRS issued Private Letter Ruling 201833012, confirming that a design to provide nonelective contributions to employees who make payments to their student loans “would not violate the ‘contingent benefit’ prohibition of Sections 401(k)(4)(A) and 1.401(k)-1(e)(6).”

The contingent benefit rule prohibits an employer from conditioning another benefit on the employee making an elective contribution. In this case, Abbott conditioned its nonelective contribution on the employee paying off external student loans (the ruling assumed the student loans were not offered by the employer). This ruling opens many new opportunities for interested employers. These opportunities also bring new challenges.

WHY STOP WITH LOANS?

While student loans are a pressing issue, why stop there? For example, what other behavior would an employer like to encourage by providing employer Section 401(k) contributions? Paying off your mortgage? Credit card debt? Participation in wellness programs? The PLR was not specific to student loans. Rather, the PLR answered a novel question of plan design as it relates to the contingent benefit rule. This opens the door for other possibilities, assuming an employer can solve the hurdles such as eligibility, substantiation, discrimination testing, and other statutory prohibitions (e.g., the Americans with Disabilities Act rules on wellness programs).

DON’T CALL IT A MATCH

Many news outlets have reported this benefit as a “match” to an employee’s Section 401(k) plan. However, while it has an “if you contribute, then you get it” design, the PLR specifically states that this is not treated as a matching contribution for purposes of testing under Section 401(m).

The inability to categorize the contribution as a match makes meeting nondiscrimination testing more difficult and forecloses the ability to use a safe harbor design. This is because the safe harbor language in Section 401(m)(11) requires an employee to first contribute to the employer plan, making it unlikely a safe harbor design will work. Some have suggested a method of getting around this by allowing after-tax contributions, which the employee could immediately withdraw to use to pay for their loans. However, in Revenue Rulings 74-55 and 75-56, the IRS ruled that a plan permitting in-service withdrawals of after-tax contributions, to which “employer contributions are geared,” violates the anti-abuse and manipulation rules and risks plan disqualification.

So how should employers meet nondiscrimination testing? One method is to offer the benefit only to non-highly compensated employees. This may solve the problem of meeting nondiscrimination testing for the plan loan contribution. However, if too many non-highly compensated employees opt out of elective contributions, it could negatively impact nondiscrimination testing for plan matching contributions.

TO PLR OR NOT TO PLR?

With all of these questions, what should an employer do? A PLR is applicable only for the employer requesting the ruling. Other employers may not use the PLR for precedent but can try to design similar programs based on how the IRS viewed the facts. That creates uncertainty for employers interested in adopting a similar design. For example, does it apply to Section 403(b) plans? Does it work at higher percentages?

Recognizing the limited comfort that Revenue Procedure 2019-01 brings (for example, the IRS will not provide “comfort rulings”—rulings on hypothetical situations—and there is no longer a determination letter program), a PLR may be the only available option to obtain approval of a proposed plan design.

However, be aware that employers may find it difficult to obtain their own PLR and that trying to do so may be premature. There has been overwhelming response to PLR 201833012, and the current staffing situation at the IRS means they may want to avoid PLRs pouring in asking for essentially the same design. Therefore, it is more likely that the IRS will issue formal guidance. If formal guidance is issued, any PLR (and all of the work put into it) gets returned because the IRS will not provide a ruling on a guidance project. Therefore, there is benefit in waiting to see if this topic appears on the priority guidance plan. In the meantime, sort through some of the aforementioned issues prior to moving forward.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Andrea Gehman is senior associate general counsel at the Johns Hopkins University Applied Physics Laboratory LLC specializing in employee benefits, labor and employment law, and privacy.