Your 401(k) plan may help employees with student loan debt

Under tax code Section 127, you can subsidize employees’ education, tax free, up to $5,250 a year. But that doesn’t help employees who come into your workplace already saddled with debt. However, a private letter ruling from the IRS may provide you with a novel option to help employees through your 401(k) plan. (PLR 201833012)

Note: PLRs are intended as private advice from the IRS to the requesting party. They may be used for informational purposes only; they may not be used or cited as precedent.

New 401(k) plan option? 401(k) plans can’t base other benefits on employees’ electing to participate in the plan. This is called the “contingent benefit prohibition.”

The IRS was asked whether this set up violated the prohibition on contingent benefits: An employer would make a 5% nonelective contribution into employees’ 401(k) accounts if they paid back their student loans at a rate of 2% of their 401(k) eligible compensation every pay period. The employer’s 5% nonelective contribution would be made regardless of whether employees contribute any money into their 401(k) accounts.

Employees who didn’t participate in this program could continue to defer 2% into their 401(k) accounts, and the employer would continue to match those deferrals at 5%. Employees who opted into the program could also defer 2% on a pretax basis into their 401(k) accounts, but they wouldn’t be eligible to receive a 5% match, because they were already receiving a 5% contribution on their student loan repayments.

The IRS concluded that the contingent benefit prohibition wasn’t violated. IRS: The employer’s 5% nonelective contribution is conditioned on whether employees repay their student loans and not on employees’ making elective contributions into their 401(k) accounts.

DON’T STUMBLE: The IRS stressed that employees aren’t repaying their student loans with pretax dollars. It also assumed that the 401(k) nondiscrimination requirements were met. Stumbling block No .1: You can’t make similar assumptions. In other words, you must ensure that a student loan repayment program doesn’t discriminate in favor of highly compensated employees, which might not be so easy to do if employees are young. Stumbling block No. 2: The impact on safe harbor 401(k) plans remains a mystery. Stumbling block No. 3: You will need to substantiate that employees are repaying their student loans.

One-third of employers offer student debt benefits

Employers are offering more help to employees weighed down by student debt, a burden carried by about 70% of college graduates. Employer-provided benefits run the gamut from financial-wellness training and student loan debt consolidation to loan refinancing and employer-subsidized loan repayments, according to a new report by the Employee Benefits Research Institute.

Nearly a third (32.4%) of the employers responding to EBRI’s 2018 Financial Wellbeing Survey reported offering or planning to offer a student debt benefit.

Student debt assistance is an increasingly important benefit for employers because so many employees must repay college loans. Forty-five percent of families headed by someone age 35 or younger owe money for college. The average student loan balance is $30,000 when graduates enter the full-time workforce. Collectively, Americans owe $1.5 trillion in student loans.

In 2017, one-fifth of those with education debt were behind on their payments, a likely chronic source of stress that can harm productivity.

The value of student-loan benefits to employees is obvious. Employers benefit, too. According to EBRI’s research, 56% of employers that provide student debt benefits say it improves retention, 35% say it makes employees more productive and 20% say it gives them a recruiting edge.

SNAPSHOT: Millennials are the best-educated generation

Young adults today have significantly more education than previous generations. Almost four in 10 millennials between age 25 and 37 have at least a bachelor’s degree.

Bachelor’s degree or higher by age 37

Silent generation: 15%

Baby boomers: 25%

Generation X: 29%

Millennials: 39%

Source: Pew Research Service, February 2019