Good but not that easy to do- Student loans and 401(k) plans

In August 2018 the IRS “issued a private letter ruling allowing an unnamed employer to make 401(k) contributions on behalf of employees who are repaying their student loans, and although it doesn’t set a precedent for other employers, it’s an interesting development when it comes to fighting student loan debt.”[1]

The idea is that employers can contribute matching monies to their 401(k) plan based on funds repaid by the employee toward their student loans. An employee who puts $1,000 into their 401(k) plan, which for this illustration is 6% of eligible compensation, gets 3% matched or an additional $500 added by the employer, with all of the money flowing into the 401(k) plan.  Under this new plan idea, another employee who repaid $1,000 on their student loan debt would have contributed zero to the retirement plan, but the employer may still “match” $500 into the 401(k) plan.  Sounds like a good idea and will allow those who are pouring their resources into student loan debt retirement to also get some money into their 401(k) plan.

The challenge lies in the recordkeeping and auditing of the plan. In the first scenario, the plan has a record of the employee and employer contributions.  The custodian can run testing to ensure that the employer stays within all federal ERISA guidelines and does not discriminate.  The plan custodian’s software will have to be modified to capture the student loan repayment and treat it as equivalent contributions into the plan by the employee.  Further, the plan custodian, employer and plan auditor will need documented evidence of the student loan repayment.  That will take some time to set up, will require manual paperwork submission and in general will raise the cost of administration of the plan.

I think an alternative idea that would be easier to administer would be to allow the employee to repay student loan debt with vested 401(k) funds tax-free. The employee would contribute to the 401(k) program, receive their match and then request the plan custodian to make a permitted disbursement to the employee’s student loan. This loan paydown would not be a loan, rather it would be a non-taxed withdrawal. In this alternative, the custodian would have a record of the contribution, so auditing the plan, proving non-discrimination, and administering the plan would be cleaner.

Another option is to allow the employer to repay up to $10,000 annually on a student’s loan and to treat that repayment as a tax-exempt disbursement. The employer receives a tax deduction for the benefit paid but it is not taxable to the employee.  The messiness of this option is that ERISA rules may require the employer to treat the student loan repayment as a new benefit plan subject to ERISA reporting and oversight.  That would result in additional administrative cost that would discourage employer participation.

The student loan bubble is a national problem that we need creative ideas to solve. I encourage you to work with your legislators to develop new tactics to address the concern.

[1] website posted by Jessica Salerno on September 18, 2018.

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