Student loan repayment programs: outstanding issues

On August 18, 2018, the Internal Revenue Service released Private Letter Ruling (PLR) 201833012, concluding that a 401(k) plan that provided for “an employer non-elective contribution on behalf of an employee conditioned on that employee making student loan re-payments” [emphasis added] did not violate the Internal Revenue Code section 401(k) prohibition on conditioning a benefit on an employee making elective contributions.

Participants, sponsors and policymakers have all expressed significant interest in 401(k) student loan repayment programs. The IRS’s private letter ruling, however, raises at least as many questions as it answers.

In this article, we review some of the outstanding issues with respect to student loan repayment (“SLR”) programs and how they might be solved either through regulation or by the proposal included in the Retirement Security and Savings Act, recently introduced by Senators Portman (R-OH) and Cardin (D-MD).

The problem: the 401(k) contingent benefit rule

Internal Revenue Code section 401(k) provides (among other things) that:

A cash or deferred arrangement of any employer shall not be treated as a qualified cash or deferred arrangement if any other benefit is conditioned (directly or indirectly) on the employee electing to have the employer make or not make contributions under the arrangement in lieu of receiving cash. The preceding sentence shall not apply to any matching contribution (as defined in section 401(m)) made by reason of such an election.

Section 401(m) defines matching contributions as an employer contribution made “on account of an employee contribution made by such employee” or “on account of an employee’s elective deferral.”

This contingent benefit rule effectively prohibits a sponsor from making a 401(k) matching contribution with respect to a student loan repayment.

The PLR

Under the arrangement described in IRS’s Private Letter Ruling, the employer makes a contribution to the plan on behalf of the participant in connection with a student loan repayment that is functionally equivalent to a matching contribution. That contribution is, however, styled as a non-elective contribution, not a matching contribution. This approach, according to IRS, avoids running afoul of the contingent benefit rule described above.

Outstanding issues

The solution in the PLR leaves several issues unaddressed – some of them technical and some fundamental – that may prevent some sponsors from adopting this sort of program.

General application

Private letter rulings are (generally) applicable only to the taxpayer to whom they are addressed. Many sponsors may, based on their view of the validity of the analysis described in the SLR PLR, be comfortable implementing an SLR program similar to the one discussed in the ruling. But at some point we will need a rule – e.g., a revenue ruling or regulation – of general application.

Technical issues presented by “non-elective contribution” treatment

As we noted, the design approved in the PLR “works” because (among other things), sponsor contributions to the 401(k) plan that “match” student loan repayments are not treated as matching contributions but as employer non-elective contributions. This approach raises a number of issues:

The matching contribution rules under current ADP testing safe harbors must be “actual” matching contributions, that is, contributions related to a participant’s elective contributions to the 401(k) plan. Thus, SLR non-elective contributions would not count for safe harbor purposes. As a result, plans that depend on matching contributions to satisfy an ADP testing safe harbor may not be able to adopt an SLR program.

Generally, non-elective contributions must separately satisfy Internal Revenue Code nondiscrimination rules. If the participants making student loan repayments, and getting SLR non-elective contributions, are (disproportionately) highly compensated employees (HCEs), the program may be treated as “discriminatory.” A possible solution to this problem might be to limit SLR non-elective contributions to non-highly compensated employees (NHCEs).

An NHCE who gets the full SLR non-elective contribution would not, under the program described in the PLR, be eligible for any matching contributions. Does that result violate the requirement that all plan “benefits, rights, and features” (including matching contributions) be available on a nondiscriminatory basis?

All of these issues point to the awkwardness of the PLR’s solution to the contingent benefit rule problem: these issues would generally go away if SLR non-elective contributions were simply treated (for nondiscrimination purposes) as matching contributions. Some commenters have proposed that IRS do something like that.

ADP testing

Unlike the “technical” issues described above, the effect an SLR repayment program on (non-safe harbor) actual deferral percentage (ADP) testing presents a more substantive issue. If most of the participants taking advantage of the program are NHCEs, then the “regular” 401(k) contributions of those NHCEs will go down (they have, in effect, been diverted to student loan repayment), presenting an ADP testing challenge.

It’s not clear that there is an easy solution to this problem. No one, thus far, has proposed treating a student loan repayment as a 401(k) elective deferral.

Administration

Finally, there is a question about the form and amount of authentication of student loan repayments required under the program. E.g., can the sponsor simply rely on a participant’s representation?

Obviously, if more extensive documentation is required, this sort of program might become, for some sponsors, too expensive to administer.

The Portman-Cardin solution

Some industry groups have asked IRS to solve these issues through regulation. While that might be possible, it seems unlikely.

The Portman-Cardin student loan repayment proposal would solve most, but not all, of these problems. Under that proposal:

Sponsor contributions to a 401(k) plan that “match” student loan repayments would generally be treated as “regular” 401(k) employer matching contributions. As discussed above, this would solve a number of the technical issues presented by the approach taken in the PLR.

For purposes of the matching contribution rules under 401(k) (and 401(m)) testing safe harbors, student loan repayments would be treated as elective deferrals. For instance: a plan qualifies for the “general” safe harbor if the employer matches 100% of elective contributions up to 3% of pay and 50% of elective contributions in excess of 3% up to 5% of pay. The employer “match” for student loan repayments would count as a match for purposes of this rule. Student loan repayments would not be treated as elective deferrals for any other purpose.

The proposal includes a number of useful clarifications, e.g., the fact that a participant has no student debt does not mean that the SLR program is not “available” to the participant.

With respect to administration, IRS is to prescribe “the conditions under which a plan administrator may rely upon evidence submitted by an employee of qualified student loan payments.”

The proposal does not provide a solution to the ADP testing issue. As noted, for all purposes other than the safe harbor matching contribution rules, SLRs are not treated as elective deferrals.

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There seems to be a broad consensus that 401(k) student loan repayment programs are a good thing. Policymakers – both in Congress and in the agencies – are trying to develop ways to fit them into the current 401(k) regulatory scheme. The fit remains – under the PLR and even to some extent under the Portman-Cardin proposal – imperfect.

As consideration of this new sort of program proceeds, we expect more issues (both technical and substantive) to be identified and more solutions to be proposed.

We will continue to follow these issues.