I’ve been practicing in the employee benefits field for 37 years and I can’t remember being as surprised as I was reading IRS Private Letter Ruling 201833012 released on last Friday. Never before has there been any tax advantage to student loan payments (typically made to an outside financial company) through connection with an employer plan. This Private Letter Ruling allows student loan payments made by employees to be ‘counted’ the same as elective deferrals in a 401(k) plan. This outside student loan payment, then, is the qualifying condition that allows tax-free employer-provided benefit matching to be paid for the employees in the 401(k) plan without a separate additional elective contribution to the 401(k) plan. This option simply wasn’t available until now.
This provision is significant because young employees often struggle to make 401(k) elective deferrals at the same time they are making student loan payments. The Private Letter Ruling allows employees to benefit from employer payments to a 401(k) while they focus on paying their student loans. One way to look at this new 401(k) plan option is that the employer’s tax free contribution is now available to ‘cover’ the cost of the student loan payment – a tax-free way to pay a student loan – an option that was not available before.
This plan design also allows the employer to use this feature of the 401(k) plan as an employee retention tool because the employer contribution for student loan payment matching is available only to employees who stay through the end of the year.
IRS apparently required that the employer not issue the student loans directly to the employee (in which case the loan repayment would effectively receive a tax advantage that was not condoned).
This Private Letter Ruling immediately raised two questions in my mind:
- Would the deduction of the student loan payment on the individual tax return crate a double tax benefit? (Something the IRS typically does not allow).
- Does this create a financial incentive for a related party to issue the student loan, perhaps even if it isn’t needed?
These are not addressed.
Private Letter Rulings are not law and cannot be relied upon by other taxpayers. However, this feature will soon be in demand by younger employees so other similar plan designs will likely follow.