The SECURE 2.0 legislation that Congress passed in late 2022 as part of an omnibus appropriations bill made a bevy of changes to the tax code, including many updates to retirement plans. We previously highlighted that one such change is that student loan repayments can now count towards an employer match for your workplace 401(k) or other qualified plan.
This change is welcome news to folks who struggle to make both student loan payments and 401(k) contributions, so here is some more detail.
I use “401(k)” throughout this article as shorthand for any defined-contribution qualified retirement plan, such as a 403(b), 457, or federal Thrift Savings Plan (TSP).
How do matching contributions even work?
Employer matching contributions to 401(k) plans are not new, but there is no set standard requiring a certain amount for an employer to match either. Each 401(k) plan determines the rate and frequency of matching contributions, so you need to check your plan documents.
A typical explanation of matching contributions might be “100% match for the first 3%, then a 50% match on the next 2% of employee contributions.” What does that mean?
100% match for the first 3%: Whatever you contribute, up to 3% of your salary, your employer will match your contributions dollar-for-dollar.
50% match for the next 2%: After you contribute the first 3% of your salary, your employer will match your contributions on the next 2% of your salary at 50 cents on the dollar.
As a result, if you contribute 5% of your salary towards your 401(k), your employer will chip in a 4% contribution. For example, assume your paycheck is $1,000.00 and you elect a 5% employee contribution, so your contribution is $50.00 (i.e., 5% × $1,000.00). Your employer will contribute another $40.00 (i.e., 4% 5%× $1,000.00). Altogether, $90.00 is deposited into your 401(k) account. Your employer calculates their $40.00 portion as follows:
100% match for the first 3%:
3% × $1,000.00 = $30.00
employer match = 100% × $30.00 = $30.00
50% match for the next 2%:
2% × $1,000.00 = $20.00
employer match = 50% × $20.00 = $10.00
Total employer contribution = $30.00 + $10.00 = $40.00
The key here is that these are matching contributions. You must contribute a certain percentage to receive this additional money. In this example, if you are not contributing at least 5% of your salary towards your 401(k), you are literally foregoing free money. (You may certainly contribute more than 5%, up to the annual maximum, but you will not receive an additional employer contribution in this scenario.)
Relief for student loan borrowers
Due to many competing demands on their income, many folks feel they cannot afford to reduce their paychecks by 5% now for what amounts to 9% in accumulated wealth that can only be accessed later (and that is before counting exponential growth!). As a result, they unwittingly rob their future to fund their present.
One competing immediate demand for many is student loan payments. Continuing with the above example of a $1,000.00 paycheck, someone with a student loan payment that equates to $75.00 each paycheck may not have room in their budget for an additional reduction in pay of $50.00 for a 401(k) contribution. That represents $90.00 in missed contributions when combined with the employer match, plus the exponential growth on those contributions, each paycheck!
For someone paid every two weeks, this equates to $2,340.00 over the course of a year. While that may not sound like much, when invested properly each year it would grow to more than $100,000 in less than eighteen years (assuming average rates of return each year).
Now, thanks to the new section 401(m)(13) of the Internal Revenue Code, an employer may treat certain student loan payments as 401(k) contributions for purposes of determining employer contributions!
In the above example, the person paying the equivalent of $75.00 each paycheck towards their student loans would still receive an employer contribution of $40.00 towards their 401(k), even if they do not otherwise contribute to their 401(k). As long as the amount they contribute to their student loans equals or exceeds their employer match requirements, the person can pay off their student loans while their employer contributes to the 401(k). The employer calculation is as follows:
Employee “contribution” (student loan payment) is $75.00. This is 7.5% (i.e., $75.00 ÷ $1,000.00) of their salary, so it exceeds the 5% necessary for the full employer “match.”
100% match for the first 3%:
3% × $1,000.00 = $30.00
employer match = 100% × $30.00 = $30.00
50% match for the next 2%:
2% × $1,000.00 = $20.00
employer match = 50% × $20.00 = $10.00
Total employer contribution to the employee’s 401(k) = $30.00 + $10.00 = $40.00
What are the caveats?
An important caveat to the matching-contributions-for-student-loan-payments benefit is that employer plans are not required to offer it. Plans offering this benefit, though, must provide for matching contributions based on student loan payments to all employees at the same rates and vesting schedules as matching contributions based on elective deferrals (i.e., 401(k) contributions withheld from paychecks). In short, if employers match 401(k) contributions based on student loan payments, it must be done on the exact same terms as regular contributions.
Another important, but unsurprising, caveat is that each employer will have their own policies and procedures for accessing this benefit. There might be a maze of paperwork to verify your student loan payments, but securing the additional funds towards your retirement will certainly pay off. The opportunity to pay off student loans while accumulating employer-funded retirement investments is worth a mountain of paperwork.
What can employees expect?
Now that the legislation has been in place for nearly two years, more employers are offering matching 401(k) contributions based on student loan repayments. Employers should be encouraged to offer this benefit to attract and retain quality employees. Since matching contributions are a deductible business expense, it will save employers on taxes as well!
If you are paying back student loans and not already maximizing your employer 401(k) match, be sure to ask about this benefit today. If you need help working through the paperwork, schedule a consultation to work with us. Get your full employer match today, regardless of your current career stage or student loan payment!
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