Section 127 plans: The ultimate primer

Section 127 Plans: How does it work?  

A Section 127 plan is the basis for any student loan repayment benefit (or other educational assistance benefit), but what exactly is it, how does it work, and why is it necessary? We’ll walk you through all that and more in this comprehensive primer.  

Table of Contents

1. What is a Section 127 plan? 
2. Why is it called a “Section 127” plan? 
3. Why is a written Section 127 plan necessary? 
4. How do you create a Section 127 plan? 
5. What sections usually go into a Section 127 plan? 
6. What are the rules and requirements of a Section 127 plan? 
7. Are Section 127 plans subject to ERISA? 
8. How long does it take to create a Section 127 plan? 
9. Where can companies find a sample Section 127 plan? 

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What is a Section 127 plan? 

A Section 127 plan  (“127 plan” or “127c plan” for short) is the official written legal document that outlines the terms of and governs a company’s Educational Assistance program (EAP).  

Why is it called a “Section 127” plan? 

Section 127 plans are oh-so-creatively named after the portion of the Internal Revenue Tax Code that established Educational Assistance as a tax-free employer benefit. That part of the revenue code is, you guessed it, Section 127. 

Why is a written Section 127 plan necessary? 

Companies that want to offer a tax-compliant Educational Assistance benefit to employees must have a written Section 127 plan in order to provide tax-free tuition assistance, tuition reimbursement, and/or student loan repayments to their employees.  

How do you create a Section 127 plan? 

Creating a written Section 127 Plan can be a straightforward process. Here's how to get started: 

1. Decide your benefits - Which educational assistance benefits do you want to offer? tuition assistance, student loan repayments, or both.
2. Create a budget - Determine how much you want to spend total on educational assistance. This will help you decide how much tuition and/or student loan assistance you'd like to offer to each employee
3. Determine eligibility criteria - Do you want to implement tenure rules? Are you offering this benefit to certain departments only? Will you have grade requirements and functional requirements to qualify for tuition reimbursement? Do you want to institute any lifetime benefit caps? Be sure to decide who is eligible to receive tuition assistance or student loan repayments as you create your 127 plan.
4. ‍Create your written 127 plan - Once you decide on the main criteria of your 127 plan, our team at Highway benefits can help create a tax-compliant written 127 plan for you. Schedule a call with our team to get started. If you'd prefer to write the plan on your own, be sure to check with a lawyer to ensure your plan is tax-compliant and legal.
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What sections usually go into a Section 127 plan? 

While the guidelines around what should be included in a Section 127 plan are sparse, generally, 127 plans will include stipulations on:

• eligibility criteria (i.e. who is eligible to receive the benefit)
• benefit contribution or reimbursement amounts (i.e. how much will an employee receive each year if they meet the eligibility criteria)

As with many other official legal documents, you’ll likely also find important legal terms and conditions related to the benefit plan. 

What are the rules and requirements of a Section 127 plan? 

There are a few important rules around a 127 plan:

1. The plan cannot discriminate in favor of highly compensated employees 
2. Principal shareholders (who own more than 5% of the company) may not receive more than 5% of the total benefit amount paid each year
3. The plan must not offer employees a choice between educational assistance and other taxable benefits or remuneration (cash or noncash) 
4. Eligible employees must be reasonably notified of the 127 plan 
5. An employee may not receive more than $5,250 per year from all employers combined 
6. Tax-free payments can only be used for qualified education expenses

What is a “Highly Compensated Employee”? 

A “Highly Compensated Employee” (HCE) is an official IRS classification and is defined as an individual who owned 5% or more of the business at any point in a preceding tax year, OR was paid more in gross compensation than the IRS-defined limit by the business for the preceding tax year.  

What does “the plan must not offer a choice between educational assistance and other remuneration includible in gross income” mean? 

Employees who don’t receive tax-free educational assistance payments are not allowed to receive cash, a stipend, or another voluntary, non-educational benefit instead. 

Who is considered an eligible employee?

At a bare minimum, an eligible employee is any individual who can legally be considered an employee of the business. However, companies can establish their own criteria to refine who is actually eligible to receive educational assistance payments.   

Spouses and dependents of employees are not eligible to participate in Section 127 plans.   

What does “reasonably notified” mean?

Section 127 plans are meant to be shared with employees! Companies should leave enough time between when they announce their new Educational Assistance program and when the benefit goes into effect to give eligible employees a chance to read through the 127 plan, ask questions, and enroll in the benefit. 

What are qualified education expenses? 

Qualified education expenses include tuition, other fees, books, supplies and equipment for instruction, student loans, and other similar expenses. They do not include meals, lodging, transportation, supplies or equipment that an employee keeps after a course has ended, or tuition for any courses involving sports, games, or hobbies. 

Are Section 127 plans subject to ERISA? 

Section 127 plans are not required to be funded and are not currently subject to ERISA. 

(ERISA, or the “Employee Retirement Income Security Act”, is a federal law that establishes minimum standards for voluntary retirement and health plans)  

How long does it take to create a Section 127 plan? 

How long it takes to set up a Section 127 plan depends entirely on you. The hardest part about creating a Section 127 plan is figuring out how much to budget and what terms are right for your company’s plan. But once your company has figured out the benefit amount(s) and eligibility criteria, a written 127 plan can be set up quickly. Highway Benefits can help you set one up in less than a day. 

Where can companies find a sample Section 127 plan? 

Companies that want to set up an Educational Assistance benefit under a Section 127 plan, including student loan repayment benefits, can download our free 127 Plan Template workbook, to start designing their educational assistance benefit. The workbook also includes a link to a free sample 127 plan starter template.

If you need some guidance as you craft your plan rules or have questions about your options, our team at Highway Benefits can help. Speak with an expert today! 

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