Before you start petitioning your human resources department to add student loan repayments to the benefits roster, employees should temper their expectations. Here's what you need to know.
For many borrowers, repaying student loans is tough work. But achieving those debt payoff goals while fully funding a retirement savings account is even harder.
For those struggling to perform this juggling act, a tax decision made public in August from the Internal Revenue Service offered a glimmer of hope.
The private letter ruling allowed an employer — later revealed to be Abbott Laboratories, based outside of Chicago — to use a program in which employees’ student loan payments could be matched by employer contributions to a 401(k) retirement savings account, even if the employees weren’t contributing to retirement on their own.
Here’s what this means if you’re not fluent in HR-speak. Typically, an employer will match a certain percentage of the contributions a worker dedicates to her 401(k) retirement account. So if Barbara allocates 10 percent of her paycheck to an employer retirement fund, her employer may match up to, say, 4 percent of those contributions with its own money. That’s free money for Barbara, and it has tax benefits for her boss.
This new ruling builds on that setup. It allows employees of Abbott who contribute at least 2 percent of their paychecks to student loan repayments to earn a 5 percent 401(k) contribution from Abbot Laboratories, regardless of whether they also make contributions to their retirement accounts. That’s free retirement money for student loan borrowers, with the same tax benefit for Abbott.
“For employees who can’t afford to contribute to a 401(k) because of student loan debt, this would be a godsend,” says Phyllis Jo Kubey, enrolled agent and certified financial planner in New York City.
But before you start petitioning your human resources department to add this benefit to the roster, Kubey warns, employees should temper their expectations. A private letter ruling is not a new tax law. Right now, this rule applies solely to Abbott Laboratories. “The key thing is that a private letter ruling may not be relied upon as precedent by other taxpayers or by IRS personnel,” Kubey says.
While this benefit won’t be adopted by your boss unless more formal changes are implemented, it’s still worth thinking about the implications of favoring your student loan repayment over your retirement savings, says Shannah Compton Game, certified financial planner and host of the podcast “Millennial Money.”
“It may not apply to you, but it’s expanding your brain, thinking, ‘Oh, that may be an option for me down the line,’ so you have this awareness,” Game says.
The reality is that it depends on the type of saver you are. For example, if without this program you would have focused your full attention on student loan repayment, ignoring your employer retirement account and contributing nothing, this benefit would be a crucial way to start a retirement fund.
On the other hand, if without this benefit you’d have repaid student loans and contributed to your retirement plan, but now you’re not putting any of your own money toward your 401(k), this could set you back, convincing you to limit long-term savings and leaving you broke at retirement.
It’s also important to note that young people who are repaying student loans are at the prime time to fund retirement savings. Money invested in their 20s and 30s will have more time to grow and benefit from compounding interest than money contributed during middle age. Ignoring retirement savings early on in a career could prove disastrous down the road. So these are all important decisions, despite the fact that retirement may be decades away.
The ideal situation would be to prioritize both student loan payments and retirement savings, experts say. For example, you could use income-based repayment, Public Service Loan Forgiveness, private loan refinancing or other repayment options to make student loan bills manageable enough to where you can also focus on contributing to your company’s retirement savings account.
Another factor to consider are the tax implications of rerouting retirement contributions to your student loan account. Money contributed to a 401(k) reduces the income you are taxed on, resulting potentially in a smaller tax bill or increased tax refund. Student loan payments don’t carry that benefit. That means choosing to prioritize student loan repayments over retirement savings could have an unexpected impact on your finances come Tax Day.
For now, the tax questions are solely being made by a small group of employees in Chicago. Says Game: “If you’re lucky enough to work for this particular company, you’re one of the guinea pigs.”