IRS Private Letter Ruling Offers Employee Choice Between Tax-Favored Benefits

Recent PLR Approving Choice Arrangement

Background: The employer who requested this PLR sponsors a 401(k) retirement plan with two kinds of employer contributions. The first employer contribution is a safe harbor non-elective contribution and the second employer contribution is a discretionary non-elective contribution (hereinafter referred to as “discretionary contribution”); both employer contributions are based on a certain percent of an employee’s eligible compensation. Employees are eligible for the discretionary contribution after completing one year of employment, and the employee must be employed on the last day of the plan year (subject to certain exceptions as well as a six-year graded vesting schedule) to receive the funds.

This employer also provides the following tax-favored benefit plans to eligible employees:

• Retiree HRA: Employer makes a notional contribution to this retiree HRA for eligible employees (eligibility entails the employee retiring at age 55 or older with at least 10 years of service) to reimburse eligible medical expenses under Internal Revenue Code (IRC) Section 213(d) and are excludible from gross income under IRC Sections 105(b) and 106.
• HSA: Employer HSA contributions coupled with employee HSA contributions do not exceed the annual statutory HSA contribution limits (2025: $4,300 for self-only and $8,550 for family).
• IRC Section 127 educational assistance program: Solely for employer payments of principal or interest on employees’ education loans:
  • COVID-related student loan legislation included a temporary provision permitting employers to provide tax-free payments of up to $5,250 toward employees' student loans through the end of 2025. See prior Risk Strategies articles here and here for more information.

Proposed Amendments: The employer requested a PLR seeking approval from the IRS to amend its 401(k) plan. The proposed amendments would allow employees to make an annual irrevocable election to allocate a portion of the discretionary contribution to either the 401(k) plan or any of the three benefit plans listed above, without jeopardizing the tax qualifications of all four benefit plans.

Eligible employees would make the annual irrevocable election choice during open enrollment. If an employee does not allocate the full amount of the discretionary contribution or does not make their election, the discretionary contribution (or the non-allocated portion) would default to the 401(k) plan by March 15 of the following year, and it would vest immediately.

Additionally, employees choosing to allocate the discretionary contribution to either their HSA or to the Section 127 educational assistance program would not be eligible for pre-tax HSA contributions or other Section 127 educational assistance program benefits until after the March 15 contribution date of the following year to avoid exceeding applicable benefit limits under IRC Section 223(b) or Section 127(a)(2), respectively.

Ruling: The PLR approved the employer’s proposed amendments to its 401(k) plan. The PLR provided detailed analysis confirming these proposed amendments do not cause any of the four benefit plans at issue to run afoul of applicable IRC regulations that would jeopardize the tax qualification of each plan as well as the tax advantages for employees participating in each plan.

Notably, employees cannot be provided a choice to receive the discretionary contribution amount in cash or taxable benefits to safeguard against constructive receipt doctrine issues.

Private Letter Rulings

Private letter rulings are issued only for the parties requesting them and cannot be relied on as binding authority or cited as precedent. Nonetheless, they provide useful insight into the IRS’s general stance on taxation issues. This PLR provides valuable guidance for employers contemplating an arrangement that permits employees to choose among discretionary contributions to available tax-favored benefit plans. Employers interested in exploring an arrangement similar to the facts presented in this PLR are advised to consult with their own counsel before implementing such a program.

Employer Considerations

This PLR arrives at a time when many employers have multigenerational workforces. Offering employees at different stages in their career (and life) a choice to allocate discretionary contributions to various benefit programs can meet the unique needs and preferences of employees. These choice arrangements can enhance employee relations and also bolster an employer’s recruitment and retention strategy. For instance, employees fresh out of college/graduate school might be interested in choosing to elect the discretionary contribution to offset their student loans, while seasoned/mature employees might be more interested in allocating it to their retiree HRA, 401(k) plan, or HSA.

If an employer implements a choice arrangement similar to this PLR’s facts and plan design (in consultation with their own counsel), they are encouraged to clearly and effectively communicate the choices, flexibility, and potential limitations that employees have to allocate discretionary contributions to applicable benefit plans.

Employers should also consider the practical items outlined below when exploring implementing an arrangement similar to the one presented in this PLR:

• Nondiscrimination testing concerns under the 401(k) plan and HSA plan (presuming employee and employer HSA contributions are made under an IRC Section 125 cafeteria plan), which are not addressed in the PLR but will still be required.
• Administrative/operational burden concerns that could arise with earmarking discretionary contributions to a variety of tax-favored benefit programs, and shoring up applicable practices and processes accordingly.

Risk Strategies is committed to keeping employers informed and up-to-date. Reach out to your Risk Strategies account team with any questions or email us directly at benefits@risk-strategies.com.