IRS Ruling on 401(k) Discretionary Contributions

On August 23, 2024, the IRS gave its approval to a novel arrangement in which employees participating in their employer’s 401(k) plan would be permitted to elect to allocate certain employer discretionary contributions made under such plan among various other types of employee benefits offered by the employer. In private letter ruling (PLR) 202434006, the sponsoring employer proposed to amend its 401(k) plan, and other plans listed below, to permit eligible employees to elect to allocate, within limits, a portion of the 401(k) employer discretionary contributions made on their behalf among the 401(k) plan itself and/or:

• A retiree health reimbursement arrangement (HRA);
• A health savings account (HSA); and
• An educational assistance program used to repay student loans.

In a somewhat surprising move, the IRS determined that, as long as specified conditions are met (see below), the proposed arrangement would not cause the various plans to run afoul of the Internal Revenue Code rules (including those regarding taxation) applicable to the plans, as more fully elaborated in the ruling.

CAUTION! Private letter rulings do not carry the force of law and, technically, apply only to (and may be relied on only by) the entity that requested the ruling. Nevertheless, PLRs do provide helpful information as to the IRS’ current thinking on a matter, including how the agency would likely rule in a similar situation under identical or nearly identical facts. 

What are the Conditions Specified in the PLR?

The PLR generally describes the facts and proposals presented by the employer, which effectively represent the conditions that the arrangement would be required to continue to meet in order to retain the IRS approval, including the following:

• 401(k) Plan. The existing employer discretionary contribution under the 401(k) plan would be reduced, and a secondary employer discretionary contribution, equal to a specified percentage of compensation, would be provided that would be subject to allocation by eligible employees among the 401(k) plan and the other benefit plans listed above.
• Eligible employees would be required to make an annual irrevocable election during the open enrollment period for the upcoming plan year.
  • If an eligible employee does not make an election, then the full amount of the secondary employer discretionary contribution would be automatically allocated to his or her 401(k) plan account, and—importantly — would become immediately 100 percent vested.
• Eligible employees may not elect to take cash or any other taxable benefit in lieu of the secondary employer discretionary contribution.
• Retiree HRA. An eligible HRA under the arrangement may only be a retiree HRA; eligible employees may not elect to allocate secondary employer discretionary contributions to an HRA for active employees.

• For plan years beginning in 2025, the maximum amount that may be contributed to an HRA under IRS rules is $2,150.
• Depending on the amount of the secondary employer discretionary contribution as determined by the terms of the 401(k) plan, and the employee’s other choices, the above amount may be reduced.
• HSA. Under the Internal Revenue Code, HSA eligibility is contingent upon coverage under a qualifying “high deductible health plan” (HDHP).
  • For plan years beginning in 2025, the maximum amount that may be contributed to an HSA (taking into account both employee and employer contributions) is (i) $4,300 for individual coverage; and (ii) $8,550 for family coverage.
  • Again, depending on the amount of the secondary employer discretionary contribution as determined by the terms of the 401(k) plan, and the employee’s other choices, the above amount may be reduced.
• Educational Assistance Program. An eligible educational assistance program under the arrangement must be exclusively purposed to help the employee pay off qualified student loans.
  • Under the Internal Revenue Code, the maximum amount that may be contributed to such an educational assistance program is currently $5,250.
  • Once again, depending on the amount of the secondary employer discretionary contribution as determined by the terms of the 401(k) plan, and the employee’s other choices, the above amount may be reduced.
• Miscellaneous. Employee allocations must only be taken from employer discretionary contributions made to the 401(k) plan and earmarked for these employee allocation purposes. No changes to other contributions (such as “safe harbor” non-elective contributions) may be made to the 401(k) plan.
• Certain questions, such as potential nondiscrimination testing issues under the 401(k) plan, and compliance with the HSA comparability rules, are not addressed in the PLR.

Key Takeaway

The novel approach described and “blessed” in PLR 202434006 could help provide employers with a unique way of offering their eligible employees some flexibility in customizing their own benefit package meeting their individual needs. Rather than a “one size fits all” approach, employees may welcome the chance to play a more active role designing their own benefit plan coverage. That said, accurate communication as to the terms and conditions of the various benefit plans is essential, while employers should avoid trying to steer employees in any particular direction when it comes to making these decisions.

This article is not meant to offer a detailed analysis of PLR 202434006 or the legal rules relating to 401(k) plan contributions, HRAs, HSAs, Educational Assistance Programs, or other requirements applicable to 401(k) plans or other types of retirement plans (such as defined benefit plans, governmental plans, individual retirement accounts or 403(b) plans), or health and welfare benefit plans. As always, be sure to consult with your own ERISA attorney or other professional advisor for individualized advice with respect to your plan’s unique situation.