“Encouraging” the Repayment of Student Loan Debt

by | Oct 1, 2018 | 401(a)

By Jeff Chang

Many of the public agencies we work with have expressed a strong interest in programs and arrangements that will help or encourage their employees to pay off their student loan debts. These programs can be important recruiting, retention and collective bargaining tools for employers. Frankly, under existing tax law, there are few — if any — ways for an employer to “help” its employees with the repayment of student debt incurred prior to employment on a nontaxable basis. This is because practically all “employer-made” payments for or on behalf of an employee will be considered taxable, unless a specific statutory exclusion from income is available. As a result, if an employer helps an employee repay his or her student loan by directly or indirectly paying the lender, this will generally be considered additional taxable income to the employee. 

Although we have not yet come up with a way for employers to help with student loan repayment on a nontaxable basis, we have developed a good way that public agencies can “encourage”  employees to repay their student loans – on a tax-advantaged basis! The concept is fairly simple; however, agencies need to carefully think through the details of such an arrangement before launching forward.

A public agency employer that wishes to encourage student loan repayment can adopt a new discretionary defined contribution plan, or amend an existing plan of that type, to provide for employer contributions that will be based on how much each employee deducts from their pay to repay student loans. Although the employees will not directly receive the amount of the loan payment as additional compensation, the employees will receive an immediate plan contribution equal to a significant portion of their payment (e.g., 100 percent, 75 percent, 50 percent, etc.). The plan contribution serves two purposes:

  • First, it provides employees with an immediate tax-deferred “bonus” for making their student loan payments.
  • Second, it takes financial pressure off employees, because they know that they are saving for their eventual retirements at the same time they are eliminating their overall debt.

As mentioned earlier, the concept is relatively simple, but the implementation might be a little more tricky.

  • First, you have to review your existing defined contribution plan(s) to see which one can be used for this purpose. If you don’t have any appropriate plan already in place, you may have to adopt a new one.
  • Second, you have to consider how much you are willing to contribute for this purpose. In general, public employers have a lot of discretion and latitude in designing “discretionary” contribution formulas. So, do you want to place a per-participant cap on contributions (on a per-payroll basis or on an annual basis)? Do you want to base employer contributions on the employees’ incomes (i.e., contributing more for lower-paid employees)?
  • Third, you have to talk with your payroll provider (or your payroll department). Such a program will work best if the employees’ loan repayments are made through authorized payroll deductions. If this is done, the employer’s human resources department can arrange for immediate payroll-by-payroll plan contributions. We have checked with several national payroll services and have determined that this can be set up at a relatively low cost. When employees know (and can see) that their retirement accounts are growing with each payroll, the incentive aspect of such a program will be most powerful.
  • Fourth, you have to make sure that any plan changes, or new plan provisions, will comply with all applicable federal and state laws, including the California Public Employees’ Pension Reform Act, or PEPRA.

Jeff Chang is a partner at Best Best & Krieger LLP. He has four decades of experience skillfully evaluating benefit and retirement plan compliance to achieve maximum outcomes for public agency clients throughout California. He can be reached at jeff.chang@bbklaw.com or (916) 329-3685.

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