We interrupt your regularly scheduled programming to highlight the IRS’ not-so-ground-breaking entrance into the world of student loan benefits in 401(k) plans.
The ever-growing mountain of student loan debt has been on the minds of everyone from high-schoolers trying to select a college to graduates trying to decide where they can afford to live to politicians who want to be seen as solving the problem. Some larger companies have even implemented student loan forgiveness benefits to help attract top talent in a tight labor market.
The IRS entered the fray on Friday (August 17, 2018) when it published Private Letter Ruling 201833012 dealing with the interplay of student loan benefits and 401(k) plans. We have already seen a number of articles with headlines that suggest the PLR has created some new rule to pave the way for 401(k) plans to include these added benefits. Unfortunately, on first blush, it looks like much ado about nothing.
The company that requested the ruling had a 401(k) plan that provided a matching contribution equal to 5% of pay for any employee who contributed at least 2% of pay, determined on a pay-by-payroll basis. It is a bit convoluted to follow, but their proposal was to amend the plan to add a special student loan benefit as follows:
- Separate enrollment: Plan participants with outstanding student loans could sign up to receive the separate student loan benefit. That sign-up would be separate from the regular plan enrollment.
- Nonelective contribution: For those who sign up and make payments on their student loans in an amount equal to at least 2% of their compensation, the company would make a nonelective contribution (a/k/a profit sharing) equal to 5% of compensation.
- True-up match: Those employees enrolled in the special benefit who did not make the required minimum loan payments, but who did defer at least 2% into the 401(k) plan, would receive a so-called “true-up” match using the same formula as the regular match, i.e. 5% of pay.
Although calculated on a pay period basis, neither the student loan benefit nor the true-up match would be funded until after the close of the year, and participants would be required to be employed on the last day of the year to actually receive either benefit.
The Issue and the Ruling
There is a little-known rule in the Tax Code called the contingent benefit rule. In short, it says that that the only benefit in a qualified plan that can be conditioned on a participant making 401(k) deferrals is a matching contribution. As an example, that means it would not be acceptable to require a participant to make 401(k) deferrals in order to receive a profit-sharing contribution.
The company seeking the PLR wanted confirmation from the IRS that its student loan benefit would not violate that contingent benefit rule. Unsurprisingly, the IRS ruled that the benefit, as proposed, would not run afoul of that rule. We say it is unsurprising because no part of the student loan benefit is based on whether or how much an employee defers.
Nothing To See Here
The PLR does not break new ground, provide any new interpretations, or create any new laws or plan design opportunities. It answers just the one simple question. With that said, the concept of a student loan benefit inside a company-sponsored plan is a novel one. Let’s take a look at how the proposal from the ruling might play out in practice. After all, just because a concept is legal doesn’t always mean it is practical.
Nondiscrimination testing is the big issue here. As a general rule, every type of contribution a plan provides is subject to the minimum coverage test to ensure that enough non-highly compensated employees are eligible to receive it. Since most highly compensated employees are unlikely to have student loans, most of the people benefitting are likely to be non-HCEs, putting this design in the clear on the coverage test.
But what about the other nondiscrimination tests? The student loan benefit replaces the company match for those participants who enroll and make the requisite loan payments. Since matching contributions are subject to the ACP test and the loan benefit effectively reduces or eliminates the matching contributions made for non-HCEs, this design has the potential to cause the ACP test to fail.
Moving beyond nondiscrimination testing, we would be remiss if we didn’t also mention the plan document. Prototypes and other plan documents that are pre-approved by the IRS are unlikely to be able to accommodate designs like this. That means the company would have to engage an attorney to draft a customized plan document that incorporates all the necessary wording. That can be a very expensive proposition, and since the IRS has cutback on which types of customized documents for which it will issue determination letters, sponsors may be left with plan provisions that may or may not be acceptable but without any way to know for sure.
For Your…er…Their Eyes Only
It is important to note that while a PLR can be illustrative of the IRS’ thought process, it is based on the specific facts outlined in the request and is only binding on the party doing the requesting. A PLR does not set precedent and cannot be cited by other taxpayers in support of their own reasoning. So, just because the IRS ruled that this particular student loan benefit does not violate the contingent benefit rule, that does not mean that other types of student loan benefits within 401(k) plans would automatically be acceptable. With the cost of a PLR tipping the scales at five figures, that is not going to be a viable option for most businesses.