For years you’ve been encouraging your employees to save for retirement. But what about other savings programs? The growing popularity of 529 College Savings Plans provides employers the chance to offer employees a valuable benefit at virtually no cost.
529 College Savings Plans are education savings plans designed to help families set aside funds for future college costs. Named after section 529 of the tax code, these plans are generally sponsored by individual states. Most states work with independent investment management companies to run the program and provide participants with investment options.
Plans are usually categorized as either savings savings or prepaid tuition plans, although some have elements of both. Under a prepaid tuition plan, you lock in future tuition rates at in-state public colleges. Higher education institutions can offer their own 529 prepaid programs, allowing employees to target tuition prepayment to the sponsoring institution. And unlike education IRAs, 529 plans have no income limits restricting eligibility. That means your hourly employees, salaried employees or executives can participate.
Investing in a 529
There are several reasons to invest in a 529 plan.
Tax benefits. Investing in a 529 plan may offer college savers special tax benefits. Earnings in 529 plans are not subject to federal tax, and in most cases, state tax, as long as you use withdrawals for eligible college expenses, such as tuition and room and board. Many states offer state income tax or other benefits, such as matching grants, for investing in a 529 plan. But you may only be eligible for these benefits if you participate in a 529 plan sponsored by your state of residence. Just a few states allow residents to deduct contributions to any 529 plan from state income tax returns.
If you withdraw money from a 529 plan and do not use it on expenses for an eligible college (or vocational/technical school), you generally will be subject to income tax and an additional 10 percent federal tax penalty on earnings. However, most plans allow participants to select a new beneficiary if the intended recipient does not attend college.
Contributions on behalf of any beneficiary cannot be more than the amount necessary to provide for the qualified education expenses of the beneficiary. Conservative, moderate and aggressive investment options are available within 529 Plans. Participants may switch investment options within the same plan once per year.
Saving made easy. Employees can also choose automatic, regular deposits through payroll deductions, typically at no cost to the employer. Payroll deductions can also reduce the cost of investing, as many fund companies will waive sales commissions and lower other expenses for those investing through payroll deduction. For employers, the plans are easier to manage than 401(k) plans because the contributions are after-tax, and there are no income eligibility rules. Best of all, unlike with a 401(k), the employer doesn’t have to do any IRS 5500 reporting.
Selecting a 529 Plan
Before scrutinizing fund managers and what they have to offer, an employer must first assess its own employee demographics. A good starting point would be to collect information on the number of employees per state, their average salaries and general classifications (married vs. single, age ranges). Then obtain data on all relevant 529 plans within each state where the company has employees.
The only notable differences among state plans are the tax benefits and the plan fees. Be sure to examine the impact of these factors on participant assets—it may be far greater than you realize. Since tax benefits, unlike projected investment returns, translate to guaranteed money, investors should be wary of choosing a 529 plan that does not offer tax benefits comparable to their own state plan.
Employers face the challenge of evaluating the trade-offs between opting for just one 529 plan or multiple plans. A benefits adviser can help you devise a 529 plan strategy for your workforce.
Key Issues in Choosing a 529 Plan
- Eligibility requirements
- Tax benefits/liability on contributions and qualified withdrawals
- Contribution limits
- Sales fees or fund expenses
- Investment options and asset allocations
- Surrender or penalty fees
- Transfer of benefits or beneficiary changes
- Historical investment returns
- Qualifications of plan managers
- Other benefits for state residents and/or non-residents
A 529 plan that is implemented efficiently and managed well can be a smart addition to your employee benefits package. Not only will your organization retain and attract talent, but you will be rewarding hard-working employees and showing consideration for workplace quality of life issues. If you are interested in establishing a 529 College Savings Plan, please call us.