401(k) Does Double Duty as a Holistic Financial Wellness Tool

Savvy Student Loan Debt Management as Part of Retirement Preparation

There has been much discussion about how student loan debt affects retirement preparation. Earlier in 2018, the IRS confirmed a solution for one plan to permit employer contributions based in part on student loan debt payments.¹ Plan sponsors may encounter complexity and compliance issues should the IRS extend access to this solution to other plans.

Don’t want to wait for the IRS? Want an effective solution you can implement today? Amend your 401(k) to:

• Change the plan loan structure to a line-of-credit basis, 
• Implement electronic banking processes and include an “auto-pay” periodic loan process, and 
• Allow the participant to borrow up to the tax code limit.² 

An example:

Let’s say you just hired a 23-year-old engineering graduate with an annual salary of $60,000. After obtaining all available forgiveness and consolidation, she is left with outstanding student loan debts of $30,000 at a 6 percent interest rate, with monthly payments of approximately $331 for the next 120 months (10 years). Paying the loan as structured will incur approximately $9,681 in interest at the conclusion of the loan.

Your 401(k) offers a 3 percent of pay-matching employer contribution on the first 9 percent of pay contributed (a stretch-match design). The plan uses graded vesting throughout six years. New hires automatically are enrolled at 9 percent of pay, pre-tax. For this engineer who has a 27 percent federal and state marginal income tax bracket, 9 percent pre-tax would be approximately $450 a month, or a reduction in monthly take-home pay of approximately $331, with a $150 monthly employer match. She makes $331 monthly student debt payments by borrowing that amount each month from the 401(k) – using electronic auto-pay functionality. Then, after three years of 36 payments at $331 each month, she increases the monthly payments to approximately $1,006 for the next two years, equaling 24 payments. All plan loans are repaid over five years, 60 months.

Assuming she receives each year a 4 percent pay increase and a 6 percent return on investments (and 6 percent interest on plan and student loans):

• After three years, her 401(k) account balance equals $27,747 with an outstanding loan balance of $8,712, and the student loan balance had been reduced from $30,000 to $22,960. 
• After five years, her 401(k) account balance equals $57,976 of which approximately $23,040 is outstanding as a plan loan, and the student loan debt has been fully retired. 
• After 10 years, her 401(k) account balance is $157,147, and there are no loans outstanding. 

Net, she contributed $64,734 pre-tax and received a match of $21,578. Interest paid to the student loan vendor was $6,067. Interest paid to the participant’s own account was $5,782. (All calculations were done by the author.)

So, for approximately the same impact on take-home pay as if she had simply paid $330 monthly on her student loan debts throughout the 10-year repayment period, this now-33 year old has no student loan debt and a 401(k) account balance of more than $157,000 – almost 2.5 times her annual income.

And, of course, she has created and/or improved her credit rating by successfully paying off her student loan.

¹Internal Revenue Service, PLR 201833012, 5/22/18, Accessed 12/31/18 at: https://www.irs.gov/pub/irs-wd/201833012.pdf See also: W. Hansen, Request for Revenue Ruling Relating to Employer Contributions to 401(k) Plan to Reflect Participant Student Loan Repayments, Accessed 12/31/18 at: http://www.eric.org/uploads/doc/retirement/ERIC%20Letter%20re%20Student%...

²IRC §72(p)(2) which allows loans of up to 100% of the vested account balance up to $10,000, and, 50% of the vested account balance up to $50,000 less the highest outstanding loan balance in the last 12 months. So, structured properly, a participant can borrow, $1 per $1 up to the first $10,000.