Enlist the Power of a 401(k)

April 08, 2013

Workable solutions for helping college graduates pay off their student loans are in short supply. Proposals to discharge the debt through bankruptcy strike many people as an unfair bailout, and recent changes in the government's income-contingent debt-relief plan were shown to unfairly benefit high earners.

The truth is that there are no good plans, let alone ones with bipartisan support. Meanwhile, borrowers overwhelmed by student-loan debt tell one horror story after another. These accounts are compounded by the fact that jobs for new graduates are scarce. If one does find employment, it may not be in his or her chosen field, and the job is unlikely to pay enough to relieve the burden of the borrower's monthly debt.

Those not fortunate enough to have wealthy parents or a rich uncle need help. So who can come to the rescue? Employers.

The existing 401(k) framework could provide an equitable solution. Under such a plan, employers that offer 401(k) savings plans would allow employees to choose allocating a percentage of their pay to their retirement accounts, their student-loan balances, or both.

Better yet, an employer that offers a company match of, say, 4 percent, would give employees the option to contribute the match to either account. For example, an employee who contributes 4 percent of his salary and receives a 4-percent company match could devote his entire payroll contribution to his student loan and 2 percent of the employer match to his loan balance. The remaining 2 percent of the company match would be routed to the employee's retirement account.

Applying the employer match to a student-loan balance or a retirement account could be determined by the employer. It is commonplace for employer 401(k) matches to vest on a set schedule, based on years of service. Matches to student-loan accounts would be no different. Employees with a 401(k) but no company match could still allocate any percentage of their pay to their retirement accounts or their student loans.

A contribution to a student-loan balance would go toward the minimum monthly payment first; anything over and above that sum would pay down principal. An employee's student-loan account would be electronically linked with the payroll administrator, just like his retirement account. As with the existing 401(k), all employee contributions would be on a pretax basis and subject to the IRS yearly limit ($17,500 in 2013).

This mix-and-match variation on the existing 401(k) is not a cure-all for student debt. But it does not amount to a bailout, it requires participants to be gainfully employed (even if not in their chosen profession), and it is an evenhanded approach that gives people a mechanism to service their debt. In short, this proposal might be considered a modest tax break, or more accurately a monetary contribution from an employer.

Would such a plan have bipartisan support? Why not? The government already allows pretax contributions for health-savings accounts, child-care expenses, health-insurance premiums, employer-sponsored life insurance, mass-transit costs, and union dues. While the government may not be able to recapture tax revenues from pretax student-loan payments, as it does with a typical 401(k) by taxing distributions, the impact on the federal deficit would be no greater than that of the pretax benefits the government already offers.

Moreover, the motivation to pay down student debt little by little is the same as setting money aside for one's retirement—any contribution, no matter how small, pays big dividends in the future. In the case of student loans, any additional payment on the principal could shave years off a repayment schedule.

If the government considers the alternative—forcing hundreds of thousands of current and future borrowers into default, with no realistic way of ever collecting the entire amount—then offering a small tax incentive within a framework that already exists seems to be a promising compromise. Most important, this proposal gives people some aid in dealing with a burdensome debt. And it doesn't require a rich uncle.

Shannon Robert Summers is a lawyer in St. Louis. His student debt stands at $83,002.38; the expected payoff date is July 21, 2034.