Uncertainty about student loan forgiveness complicates use of 401(k) provision

Employers can soon choose to let workers’ student loan repayments count toward 401(k) matching contributions under a recently enacted benefits law, but many are wary of taking that step while so much is unsettled about federal loan forgiveness programs.

The program, part of the SECURE 2.0 Act, was designed to address concerns that too many workers burdened with student debt are funneling money to their loan service providers instead of their 401(k)s, missing out on the “free money” available through employer matches. Employers’ use of the program could be clouded by uncertainty about a Biden student debt relief plan that’s held up in federal court, as well as proposed rules to transform income-driven repayments.

The SECURE 2.0 provision will take effect in early 2024, meaning companies will soon be given a choice by their benefit service providers about whether to adopt plan revisions that would treat student loan repayments just like qualified plan elective deferrals.

Ensuring young workers start saving for retirement early is a critical first step in generating a sizable investment. By allowing matches to be calculated based on student loan repayments rather than just on elective retirement deferrals, lawmakers want to stave off a growing retirement access gap.

But employers are getting mixed signals about how to communicate with their workforce about the new program and how student loan forgiveness should be factored into their decision to take part.

“This is a car crash we can slowly see coming,” said Sophie Raseman, head of financial solutions at Brightside Benefit Inc., a financial wellness benefit provider. “We have no idea where we are going to land by the end of the year or early in 2024. There are more moving parts right now than I have ever seen in 20-plus years of looking at the student loan program.”

FORGIVENESS FOLLY

Employee input is a key driving factor whenever deciding whether to amend a 401(k) or 403(b) plan, benefits advisers say. Whether $10,000 to $20,000 per borrower is slashed under the Biden administration’s Covid-19 forgiveness plan could drive interest in or away from retirement plan-connected student loan benefits.

Meanwhile, changes the Department of Education has proposed to its income-contingent repayment plans could mean many workers are paying much less on monthly student loan bills. Money spent on monthly payments could actually be better used building a nest egg, Raseman said.

“There is so much unknown right now,” she said. “How can an employer or an employee decide to change their retirement plan to help workers pay back their student loans without having the full picture? That’s money out the door that could be sitting in the 401(k) generating interest.”

Two challenges to Biden’s partial Covid-19 student loan forgiveness plan are awaiting a Supreme Court ruling after oral arguments in February. Even if the conservative majority strikes down the order, lawyers for the White House have expressed some interest in finding other avenues to cut borrowers’ loans.

“The Supreme Court’s decision here is important,” said Matthew Chiarello, a partner at Snell & Wilmer in Phoenix. “That could generate interest in the student loan space. Employees might lean on employers to find other avenues for assistance.”

MORE UNKNOWNS

New data from the Employee Benefits Research Institute and the Investment Company Institute show some savings progress for younger 401(k) participants in their 20s, who saw some of the highest account balance growth between 2016 and year-end 2020.

“Younger 401(k) plan participants, whose relatively smaller initial account balances benefited from contributions as well as market returns, saw the highest growth rates over the period as their average 401(k) account balance rose 57.4% per year, on average,” said Sarah Holden, ICI’s senior director of retirement and investor research.

The lower starting point for young workers newer to the 401(k) market means that even a sizable percentage gain often doesn’t translate into a nest egg that’s growing significantly in real dollars. But the narrative of growth for these savers could detract employer attention from revising plans to fit their long term needs.

Companies that do seek to bolster younger retirement savers also still know very little about what the SECURE 2.0 Act student loan matching program will look like if they choose to adopt it next year. Chiarello said there are lots of outstanding questions employers are asking about their fiduciary duty to determine whether loan repayments have actually been made and how loan-based matches would stack up against other workers’ account balances when conducting retirement plan non-discrimination testing.

The law also wasn’t entirely clear whether the matching program affects just qualified federal student loans or private, repackaged, or refinanced loan products. It’s also not clear whether student debt applies to the student or the borrower, who can sometimes be a friend or relative.

The IRS has said it aims to deliver some clarity this summer, but that could be too little too late on top of other loan unknowns.

“There are parents who take on student loan debt for their children,” Chiarello said. “Some of these things are clearer than others. What exactly the parameters of this will look like, we still don’t know.”