Student Loans and 401(k)s: IRS Private Letter Ruling Opens the Door to a New Recruitment Strategy for Employers

Today I break from the newsletter’s traditional format of discussing an in-depth labor and employment legal issue to write on a topic of widespread application and an issue of personal interest to me – student loans, and a great new benefit employers may provide related to them courtesy of the Internal Revenue Service (“IRS”).

The IRS recently issued Private Letter Ruling (“PLR”) 201833012, available at https://www.irs.gov/pub/irs-wd/201833012.pdf, which has the potential to fundamentally alter employers’ retirement plans while offering an excellent marketing opportunity for employers to attract new talent fresh out of college. How does it do this? The short answer is by adding a new method for employers to contribute to employees’ 401(k) retirement accounts linked to employees’ student loan payments.

401(k) Plans Historically

Most people are familiar with a 401(k) plan, which the IRS defines as “a qualified profit-sharing plan that allows employees to contribute a portion of their wages to individual accounts”—in other words, it allows an individual to place money in a tax-deferred savings or investment account for retirement purposes. These employer-sponsored plans are quite popular, with 79% of American workers working for an employer that sponsors a 401(k) retirement plan.

The Internal Revenue Code authorizes employers to contribute to an employee’s 401(k) account, and many do. This is done by matching an employee’s contributions on a dollar-for-dollar basis, up to a statutorily defined maximum. Employers often state this benefit as a percentage of salary, i.e., a typical plan might offer to match an employee’s 401(k) contributions up to 5% of his or her annual salary.

From the employee’s perspective, this is a great benefit as it is essentially additional income (albeit deferred). And from the employer’s perspective, this is a good way to attract and retain good employees.

The Student Loan Problem & PLR 201833012

In theory, all of the foregoing is great. But what if you are a recent college-graduate at your first job, faced with the responsibility of juggling living expenses, including making those first student loan payments? In that case, a 401(k) employer matching program may not be immediately valuable when retirement is far in the future and student loans need to be paid now. In other words, a new junior employee may not have enough income to make 401(k) contributions and therefore may miss out on his employer’s match.  A junior employee may not have enough income to make 401(k) contributions and therefore may miss out on his employer’s match.

This is a common problem. According to the Federal Reserve, Americans held a total of $1.489 trillion in outstanding student loans as of 2017. This equates to an average of $37,172 in student loans per college graduate, exceeding credit card and automobile loans balances for most people. Yet the average starting salary for a bachelor’s degree recipient is $50,219, meaning the average student loan balance accounts for 75% of a graduate’s starting annual salary. Despite the advent of income-based and other repayment plans available under certain loan programs, once living expenses are accounted for, new graduates often find student loans a significant ongoing expense-eliminating such luxuries as vacations, saving for a rainy day, and retirement planning. And aside from employer or government-sponsored public interest repayment programs in certain fields, employers by and large have not been involved with employees’ student loans.

PLR 201833012 is poised to change that. The taxpayer in that PLR requested and received permission from the IRS to amend its 401(k) plan to allow two options: first, the traditional employer match based on an employee’s own contribution; and second, a novel option that would base an employer’s match not on any employee contribution to the 401(k) plan, but rather on an employee’s payment of student loans. This means that under the plan as structured in the PLR, an employee would automatically receive employer 401(k) contributions of 5% of the pay period’s compensation in each pay period that the employee pays a student loan payment equal to or exceeding 2% of the compensation for that pay period–a student loan payment which the employee has to pay regardless.  Thus a recent graduate no longer needs to forego retirement saving in order to pay student loans and living expenses—he or she may even be able to go on a vacation every once in a while.

Granted, I’ve painted a caricature of a nearly destitute new employee, but the reality is, even for employees that have some years’ of experience, the ability to link retirement saving to student loans (that have to be paid anyways) offers employees flexibility that is unprecedented and certainly valuable, as employees can shift some of their funds to other endeavors and still build retirement wealth.

The Forefront of a New Opportunity

This potential new employee benefit offers employers an excellent marketing opportunity to attract and retain top new talent, while also helping their existing workforce. If a candidate has two equally lucrative opportunities straight out of college, but one employer would allow him or her to pay down student loans while also building retirement wealth while the other employer’s 401(k) follows the traditional plan format, all things considered the candidate is more likely to choose the former. What’s more, the plan amendment in the PLR was structured such that employees have the option of following the traditional plan matching format if that is preferable for their financial situation, providing even more value to employees. Further, this benefit would be tax-free to the employee, whereas a direct student loan repayment benefit from the employer most likely would be taxable income to the employee.

Given the novel nature of this PLR, now is a great time for employers to investigate if such a plan amendment is worthwhile to increase their marketability to younger talent. I suspect that this will become standard benefits practice in the coming years, so by acting quickly, employers can get ahead of the curve.

Of course, there are caveats. First, an IRS private letter ruling is only legally binding as to the entity that requested it, so other employers may not rely on PLR 201833012, although it does give a strong indication of IRS policy on the issue. Second, this article speaks in general terms—401(k) plan benefits are a nuanced area of law, so employers are advised to consult their benefits counsel to determine if such a plan amendment is feasible for their organization.

Nevertheless, I believe given the widespread proliferation of student loan debt, this potential benefit is worth exploring by employers as a marketing tool. Having endured the weight of student loans myself, I can say that I definitely would have viewed a 401(k) employer match tied to my student loan payment rather than to my own retirement plan contribution as a great benefit when I was first starting out. Your candidate pool may well feel the same.

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