IRS Gives Green Light for Employee Choice Between Different Pre-Tax Benefits

Employees increasingly request (and expect) choice in their benefits. The Internal Revenue Service (IRS) recently released Private Letter Ruling 202434006 (PLR), which approved an employer's program allowing employees to allocate an employer contribution among the 401(k) plan, retiree health reimbursement arrangement (HRA), health savings account (HSA), or educational assistance program (offering student loan repayments). The PLR provides welcome guidance to employers seeking to offer more tailored benefits to their employees.

While the IRS states that a private letter ruling may be relied upon only by the taxpayer to whom it was issued, the PLR provides insight into how the IRS approaches these choice elections, and any employer wishing to offer a similar choice should review the guidance.

How It Works

For the arrangement to work, the employee must make an election among certain pre-tax benefits during open enrollment (generally, in the last few months before the year in which the benefit is allocated) and the amount of the benefit cannot be cashed out. For example, an employer could offer employees the choice of allocating $2,000 to any one of the following tax-advantaged benefits: 401(k) nonelective contribution, retiree HRA, HSA, and/or educational assistance. HSA and educational assistance benefits are subject to their usual limits (i.e., the maximum contribution to an HSA could not exceed $4,300 for individual coverage and $8,550 for family coverage in 2025, and the maximum pre-tax reimbursement amount of $5,250 continues to apply to educational assistance plans). Note, in the PLR, the taxpayer 100% vested the 401(k) nonelective contributions to create some parity.

Specifically, the IRS ruled that the arrangement:

• Does not create an additional cash or deferred arrangement in the 401(k) plan and the contribution is not subject to the 402(g) limit;
• Will not affect the tax treatment of contributions to and payments from the retiree HRA used to reimburse eligible medical expenses (i.e., there is no adverse tax impact to the retiree HRA);
• Does not adversely impact the HSA contribution (i.e., it can be excluded from the employee's gross income and is like any other employer contribution to an HSA); and
• Does not disqualify the educational assistance program (i.e., it can continue to reimburse up to $5,250 pre-tax to employees, including any amount under a choice election).

What Employers Should Consider

There are practical issues to consider when implementing a choice program like this. Cost is one factor, although an employer could reduce 401(k) nonelective contributions to pay for the benefit. Employers should also be prepared for the added burden of administering the required election during the prior plan year, and monitoring any applicable limits. Nondiscrimination testing for all the benefits could also be adversely affected. However, for employers desiring to satisfy employee requests for greater flexibility, this type of choice program provides an attractive alternative.

Contact your DWT benefits attorney for guidance on how to implement a choice program.