It is always smart to start saving for your retirement in various vehicles, such as a 401(k), as soon as you get into gainful employment. However, this is often easier said than done for people who leave school burdened by student loans.
Researchers based at Boston College found that college graduates who have to repay student loans have about 50% less in their retirement accounts by age 30 when compared to their counterparts who aren’t shackled by student loans.
A private letter ruling by the IRS to a taxpayer now opens the way for those with student loans to get more into their 401(k) accounts using a matching scheme by the employer.
How Does the Scheme Work?
The existing arrangement allowed employers to match the contributions made by employees to their 401(k) plans up to a prescribed maximum percentage of the employee’s annual income.
However, many employees would fail to take full advantage of the opportunity to have their contributions matched by their employers. This failure could be attributed to various reasons, such as an employee having to contribute less to their 401(k) in order to spare some funds for student loan repayment.
The new ruling allows employers to make contributions to the 401(k) retirement plans of their employees based on what those employees are spending on student loan repayment.
This arrangement is voluntary for both parties involved. For example, no employer is under any obligation to enroll for this matching plan. Similarly, no employee can be compelled to sign up for the matching plan.
How Does an Employee Benefit?
Employees have a chance to benefit fully from the matching funds available for 401(k) retirement plans since the student loan repayment and the deductions towards the retirement account can be used to calculate how much the employer contributes.
For example, an employee who earns $50,000 annually may contribute 3% of that salary (equivalent to $1,500) to his or her 401(k) retirement plan. The employer can match that contribution so that the employees’ 401(k) grows by $3,000 annually.
However, student loans may make you unable to contribute the full $1,500 from your salary. Consequently, your employer will only match the lower amount that you are able to contribute to your 401(k) retirement plan.
The new plan allows your employer to use the payments which you make towards your student loans as a basis for maxing out the matching program for your 401(k) plan. If you were only able to contribute $1,000 to your 401(k) account and pay $500 in student loans, your employer would still contribute the full $1,500 since your student loan payments ($500) and your actual 401(k) contribution ($1,000) would add up to the maximum fraction of your earnings which qualify for the matching program.
How Does the Employer Benefit?
First off, the employer doesn’t have to fork out any additional funds if he or she elects to enroll in this new matching program. This should settle the nerves of those employers who may have thought that this new plan imposes a burden on them.
The real benefit to the employers is that this new matching plan offers them an additional carrot to dangle before prospective and current employees. Many young people leave school burdened by student loans. Showing those young people that a company can add to their 401(k) plan on the basis of what they pay in loans (up to the acceptable upper limit) will make the company more attractive than others which aren’t participating in this matching program.
Consequently, participating employers will be able to attract and retain top talent.
This private letter ruling provides a glimmer of hope for employees who would like to put more into their 401(k) retirement plans but are hampered by student loans. What remains to be seen is how quickly employers will take up this plan and encourage their employees to enroll. Would you sign up if your employer joined the program?