How Flexible Are Your Benefits? IRS Allows Employee Choice To Allocate an Employer Contribution Among Multiple Benefit Programs

In Private Letter Ruling 202434006 ("the PLR”) released August 23, 2024, the Internal Revenue Service ("IRS") approved an employee benefits program design (outside of a cafeteria plan) that would offer employees flexibility in allocating an employer contribution among certain employer-sponsored benefit plans. Please keep in mind that a private letter ruling may be relied upon only by the entity that requested the ruling. Employers would welcome legislative or regulatory actions that would permit such flexible benefits programs to be broadly available so that having to seek their own private letter rulings would be unnecessary.

The Program Proposed in the PLR

In this taxpayer-employer’s proposed program, the employer provided that eligible employees would be given the opportunity to make an annual irrevocable election during open enrollment to allocate a discretionary employer contribution (“Employer Contribution”) among:

• the employer’s 401(k) plan,
• the employer’s retiree health reimbursement arrangement (“Retiree HRA”) (provided the employee is age 55 or older and has at least 10 years of service at the time of the election),
• the employer’s educational assistance program ("EAP") (solely for the purpose of student loan payments), or
• an employee’s Health Savings Account ("HSA") for enrollees under the employer’s high deductible health plan who are also HSA-eligible employees.

Employees must have completed one year of service to be eligible for the Employer Contribution and must be employed on the last day of the plan year (subject to certain exceptions) to receive it. The program provided that employees were not permitted to receive the Employer Contribution in the form of cash or as a taxable benefit or to allocate any part of it to a deferred compensation plan.

The proposed program provided that if no election was made by the employee as to the allocation of the Employer Contribution, the entire Employer Contribution would be made to the employer’s 401(k) plan by March 15 of the following year. If an election was made by the employee, the allocations would be treated as a contribution in the following year for the 401(k) plan, the employee’s HSA, and/or the EAP. A contribution to the Retiree HRA would be treated as a notional contribution made on December 31 in the same year as the election.

The PLR’s Specific Rulings

The employer asked the IRS for a few specific rulings, which it received, including that:

• the proposed amendment to its 401(k) plan permitting the employee-directed contribution would not cause the 401(k) plan to offer an additional cash or deferred arrangement, and the contribution would not be considered an employee pre-tax contribution subject to the annual limitation under Section 402(g) of the Internal Revenue Code of 1986, as amended (“Code”);
• the proposed amendment to the Retiree HRA would not impact the treatment of contributions to and payments from the HRA used to pay and reimburse Code Section 213(d) expenses under Code Sections 105(b) and 106 as amounts excludable from gross income;
• the proposed allocation to the employee’s HSA is excludable from gross income under Code Section 106(d); and
• the proposed amendment to the EAP would not affect the treatment of payments made under it as amounts excludable from gross income under Code Section 127(a)(1) up to the applicable limit and that the employee’s ability to allocate the contribution among the programs would not prevent the EAP from qualifying under Code Section 127.

Employer Considerations

• When To Implement. Because only the taxpayer who requests a private letter ruling can rely on it, employers who are interested in implementing a similar program for their employees should either seek their own private letter ruling from the IRS to get confirmation that the IRS approves the program or wait for legislative or regulatory action that permits such programs.
• Educational Assistance Program Limit. The provision permitting nontaxable student loan reimbursements under a Code Section 127 educational assistance program is set to expire at the end of 2025, so Congress will have to act to extend the benefit or make it permanent in order for it to be part of this kind of flexible benefit program.
• Administrative Complexity. The implementation of a similar flexible program will add a layer of complexity to plan administration and require coordination among vendors. That said, some design choices can reduce administrative complexity. For example, an employer could follow the example in the PLR and provide that no pre-tax payroll contributions to the HSA could be made until after March 15, by which time the Employer Contribution would be allocated, thereby negating the need for tracking by the administrator to avoid excess contributions.
• Nondiscrimination Testing. Employers will have to be mindful of their employee population and determine if such a program could negatively impact nondiscrimination testing results. This could include the need to apply and pass some complex and data-sensitive numeric testing.
• Program Costs. Outside of the costs to implement and administer this kind of program, employers could “reduce” the cost of the program by using (as the taxpayer in this PLR did) all or a portion of its already customary 401(k) plan discretionary employer contribution to “fund” the flexible choice program.

If you have any questions about the PLR, or any other design changes you are considering for your employee benefits program, please contact any member of our Employee Benefits and Executive Compensation practice group.