Plan sponsors may recall that Abbott Laboratories announced its Freedom 2 Save program last June. The program is designed to encourage employees to pay off their student loans by “matching” those payments with an employer nonelective contribution to the company’s 401(k) plan. Under the program, an employee who contributes at least 2 percent of his or her pay toward student loans will receive a 401(k) contribution equivalent to what the employee would have received if the employee had deferred that same amount under the plan.

The program provides employees with the best of both worlds – paying off student debt while at the same time saving for retirement.

When implementing Freedom 2 Save, Abbott obtained a private letter ruling from the Internal Revenue Service regarding the program. The IRS private letter ruling, which does not identify Abbott by name, was released last week. It addresses the single issue of whether the employer nonelective contributions for student loan repayment will violate the “contingent benefit” prohibition of Section 401(k)(4)(A) of the Internal Revenue Code and Section 1.401(k)-1(e)(6) of the Income Tax Regulations.  

According to the private letter ruling, the plan provides that if an eligible employee elects to defer at least 2 percent of his or her eligible compensation to the plan, the employer will make a regular matching contribution to the employee’s account equal to 5 percent of the employee’s eligible compensation during the particular pay period. The student loan repayment element allows the employee to use that 2 percent of compensation that the employee would otherwise have deferred under the plan to repay the employee’s student loans instead. At the same time, the employee can save for retirement with the employer “matching” the student loan repayment. The employee receives a contribution from the employer under the plan regardless of whether the employee’s 2 percent contribution is made to the plan or is used to repay student loans.

Several factors appear to make Abbott’s student loan repayment program viable. First, the program is completely voluntary. In addition, the eligible employee may, but is not required to, make elective deferrals to the plan. If the employee did make elective deferrals to the plan while participating in the student loan repayment program, the employee would not be eligible to receive a regular matching contribution on those elective deferrals (regular matching contributions are made each payroll period). Instead, assuming the 2 percent mark is met, the employee would be eligible to receive the employer nonelective contribution related to the student loan repayment, and a “true up” matching contribution for any elective deferrals made to the plan. Both the employer nonelective contribution related to the student loan repayment and the “true up” matching contribution are made as soon as practicable after the end of the plan year. Under this scenario, the employee would be eligible for a total “match” of 5 percent of eligible compensation on his or her combined student loan repayments and elective deferrals.

In addition to the above, the employee must be employed with Abbott on the last day of the plan year (except in cases of death or disability). The employer nonelective contribution and the “true up” matching contribution are subject to the same vesting schedule as the regular matching contribution. The student loan repayment employer nonelective contribution is also subject to applicable plan qualification requirements (eligibility, vesting, distribution rules, contribution limits, and coverage and nondiscrimination testing).     

As indicated above, the IRS private letter ruling addresses only the issue of whether the employer nonelective contributions for student loan repayment will violate the “contingent benefit” rule, which has often been discussed as a concern regarding the use of such a contribution.

The applicable Internal Revenue Code and Income Tax Regulations sections essentially state that a 401(k) plan cannot provide a benefit, except matching contributions, that is directly or indirectly conditioned on an employee’s election to make or not make deferrals under the plan, or election to have the employer make or not make contributions under the plan in lieu of receiving cash. In its private letter ruling, the IRS reasoned that the employer nonelective contributions related to student loan repayment are not conditioned on the employee’s making elective contributions to the 401(k) plan; instead, the contributions are conditioned on whether the employee makes a student loan repayment. Because an employee who makes a student loan repayment and receives the employer nonelective contribution can still make deferrals under the plan, the contribution related to the student loan repayment is not conditioned on the employee’s election to have the employer make or not make contributions under the plan in lieu of cash.  Thus, the IRS held that Abbott’s proposal would not violate the “contingent benefit” rules.

The IRS said that its ruling was based on the assumption that Abbott would not turn into a lender – in other words, that it would not provide student loans to employees under the program. 

The IRS did not express an opinion about any other federal tax consequences of any transaction or item discussed in the private letter ruling. Nor did the IRS express an opinion as to whether Abbott’s plan as a whole satisfies the requirements of Section 401(a) of the Internal Revenue Code. The employer nonelective contribution related to student loan repayment would remain subject to coverage and nondiscrimination testing, and the “true-up” matching contribution would be included as a matching contribution for purposes of any testing under Section 401(m) of the Internal Revenue Code.

Employers considering this approach to assisting with student loan repayments should be mindful of the many requirements that must still be met to maintain qualified plan status as well as the IRS reportable transaction rules.

It is also important to remember that private letter rulings are not general legal authority. A private letter ruling can be relied upon only by the taxpayer requesting the ruling and cannot be cited as legal precedent by other taxpayers. In addition, a private letter ruling is fact-specific, addressing only the facts presented. Thus, any employer considering using employer contributions to a 401(k) plan as a means of helping its employees reduce student loan debt should consider obtaining its own private letter ruling. This would be especially important if the employer intends to deviate from the Abbott model in any way.

Image Credits: From flickr, Creative Commons license. Yard work ad by lee leblanc, debt erasure by Investment Zen.