Pension & Benefits News IRS authorizes 401(k) plan sponsor to condition nonelective contribution on payment of student loan debt
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Monday, September 17, 2018

IRS authorizes 401(k) plan sponsor to condition nonelective contribution on payment of student loan debt

By Pension and Benefits Editorial Staff

The IRS has issued a private letter ruling authorizing a 401(k) plan to offer a student loan benefit program, pursuant to which the sponsoring employer would make a nonelective contribution on behalf of an employee who has made student loan repayments. The contributions would replace the generally applicable matching contributions available under the plan, but would not be conditioned, directly or indirectly on an employee's elective contributions. Accordingly, the IRS concluded that the nonelective contributions made by the employer would not violate the contingent benefit rule because they would be conditioned only on whether an employee made a student loan repayment during a pay period.

SLR nonelective contribution program. In the letter ruling, the IRS addressed a 401(k) plan under which an employee who makes an elective contribution (i.e., pre-tax deferral, Roth deferral, or after-tax contribution) during a payroll period of at least 2% of eligible compensation is entitled to receive an employer matching contribution equal to 5% of the employee's eligible compensation during the payroll period. The matching contribution would not be made absent an elective contribution.

The employer proposed to amend the 401(k) plan to offer a student loan benefit program, under which it would make an employer nonelective contribution on behalf of an employee, conditioned on that employee making student loan repayments (SLR nonelective contribution). Thus, unlike a traditional 401(k) plan match, the employer's matching contribution to the employee's account would be based on a student loan repayment and not on an elective contribution to the plan.

The proposed program has several distinguishing features, all of which seemed central to IRS approval.

Voluntary program. The program would be voluntary. Employees would be required to elect enrollment. Thus, an employee would not be automatically enrolled in the program. In addition, once enrolled, an employee could opt out of enrollment on a prospective basis

Continued elective deferrals. Employees participating in the program would still be able to make elective contributions to the plan. However, the employee would not be eligible to receive regular matching contributions on those contributions while participating in the program.

Eligibility. All employees eligible to participate in the 401(k) plan would be eligible to participate in the program.

Resumption of regular matching contributions. In the event an employee enrolled in the program opted out, the employee would become eligible again for regular matching contributions.

SLR nonelective contribution. The centerpiece of the program is the SLR nonelective contribution, which effectively substitutes for the employer match of elective contributions under the plan. Under the proposed program, in the event an employee makes a student loan repayment during a period equal to at least 2% of the employee's eligible compensation for the pay period, the employer would make a SLR nonelective contribution “as soon as practicable” after the end of the year, equal to 5% of the employee's eligible compensation for that pay period. Significantly, the SLR nonelective contribution would be made regardless of whether or not the employee made any elective contributions through the year.

True-up contribution. In the event an employee failed to make a student loan repayment for a pay period of at least 2 percent of eligible compensation, but did make an elective contribution during that period (equal to 2 percent of eligible compensation for the pay period) the employer would make a matching “true-up” contribution as soon as practicable after the end of the plan year. The true-up contribution would equal 5 percent of the employee's eligible compensation for that pay period.

Employment on last day of plan year. An employee would need to be employed with the employer on the last day of the plan year in order to receive either the SLR nonelective contribution or the true-up matching contribution. Exceptions would be authorized for employees terminating employment because of death or disability.

Vesting rules apply. SLR nonelective contributions and true-up matching contributions would be subject to the same vesting schedules as regular matching contributions.

Application of qualification requirements. The SLR nonelective contribution would be subject to all plan qualification requirements, including those governing eligibility, vesting, distributions, contribution limits, coverage, and nondiscrimination testing.

401(m) testing. The SLR nonelective contribution would not be treated as a matching contribution for purposes of Code Sec. 401(m) testing. By contrast, the true-up matching contribution would be included as a matching contribution for 401(m) testing purposes.

Program would not violate contingent benefit rule. The central issue before the IRS was whether the program would violate the contingent benefit rule. Under the rule, as expressed in Code Sec. 401(k)(4)(A) and IRS Reg. §1.401(k)-1(e)(6), an employer maintaining a 401(k) plan may not condition any other benefit on whether or not an employee makes elective contributions to the plan. Thus, a qualified 401(k) plan may not condition nonelective employer contributions on an employee's elective deferrals.

The IRS determined that the proposed student loan benefit program would not violate the contingent benefit rule. Focusing on the fact that the SLR nonelective contributions would be conditioned on whether an employee made a student loan repayment during a pay period, the IRS concluded that the contribution would not be conditioned (directly or indirectly) on whether or not the employee made elective contributions to the plan. In addition, the IRS, explained, because an employee who makes student loan repayments and receives SLR nonelective contributions may make elective contributions, the SLR nonelective contribution would not be directly or indirectly conditioned on the employee's election to have the employer make or not make contributions under the arrangement in lieu of receiving cash.

Narrow scope of ruling. In addition to the normal restrictions limiting application of the letter ruling (i.e., no precedential effect), the IRS cautioned that it was not expressing any opinion regarding the tax consequences of the program. Thus, the ruling is limited to application of the contingent benefit rule and expressly does not represent an IRS perspective (official or nonofficial) on whether the program satisfies all of the qualification requirement of Code Sec. 401(a). Nor does the ruling indicate whether the plan would comply with the requirements of a safe harbor 401(k) plan. However it has generated excitement by legitimizing a potential means by which employers can more effectively help employees manage an escalating student loan debt crisis within the context of the plan and without additional costs.

The IRS letter ruling can be expected to encourage the adoption of comparably designed student loan programs within 401(k) plans. Having validated the concept, the IRS can expect to see an increase in private letter ruling requests seeking approval for comparable or more expansive programs. Perhaps the volume of private ruling requests would lead the IRS to consider releasing official guidance, if not a safe harbor plan.

Source: IRS Letter Ruling 201833012.

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