Banking on a 529 plan: with minimal expense, employers can offer workers a tax-advantaged savings plan for education expenses - Benefits - Statistical Data Included

HR Magazine, August, 2002 by James Pethokoukis

It's not often that a company can serve up a new benefit to its employees for little more than the cost of fruit juice and cookies. But the Raytheon Co., a global defense-electronics contractor based in Lexington, Mass., is doing just that. The company is preparing to offer its 87,700 employees a 529 savings plan, which gives participants a federal tax break on money earmarked for higher-education expenses.

Raytheon is joining the ranks of Ford Motor Co., car-rental company Thrifty and many other companies that are making 529 education savings plans available to employees through payroll deduction arrangements. The plans, named after the section of the Internal Revenue Code pertaining to them, are created and sponsored by individual states, and typically they're managed by financial firms.

Available since the mid-1990s, 529 plans have been marketed mainly to individuals interested in saving for their children's college costs. But recent federal tax law changes sharply increased the tax advantages of 529 plans--and the volume of marketing for them.

As 529 plans continue to catch on among savers--assets doubled last year and could triple to about $50 billion by 2005--and as the plans gain appeal among employers as a low-cost employee benefit, they'll become another focus for HR. Increasingly, HR professionals will become involved in helping to decide if particular plans would work for their employees and in explaining 529s to them. "Most of the HR managers I meet don't know too much about the concept," says Leslie Lynch, education and planning consultant with Strong Capital Management. The firm, based in Menomonee Falls, Wis., runs Wisconsin's 529 plan. "But as they get more educated, they get pretty gung-ho."

How 529s Work

So far, 45 states offer at least one 529 plan. It's expected that all states will have 529 plans operating by year's end. States have varying rules on types of investments and other details, and most make their 529 plans available to non-residents.

Contributions to 529 plans are made with after-tax dollars, and now there is no federal tax on investment earnings withdrawn for higher-education costs. (Until this year, earnings were subject to federal tax, though not until withdrawal.) Some states also offer their residents tax incentives for 529 accounts.

A 529 account is set up for the college costs of a specific person. An account can be established by a parent or by someone else, such as a grandparent. Whoever opens the account controls it, even after the beneficiary reaches adulthood. The accounts also have higher maximum lifetime contribution limits--often more than $250,000--than other college savings programs. A Coverdell Education Savings Account, for instance, has a $36,000 lifetime cap. Also, 529 plans have no annual contribution limits, while there is a $2,000 annual contribution limit for Coverdell accounts and a $3,000 limit for Roth IRAs. In addition, unlike both Roth IRAs and Coverdell accounts, 529 plans have no income limits on the person setting up the account, which is a big plus for high-income families.

Since Congress authorized 529 plans in 1996, individuals have been able to sign up for them through brokers. Boston-based Fidelity Investments found that 65 percent of college savers who were surveyed said they are likely to open a 529 plan this year.

A major reason that many parents are saving now for their children's college years is the soaring price tag. The average private college costs $95,000 for four years, and the price is forecast to rise to $218,000 by 2020, according to the College Board. Costs at state schools also are expected to surge, from $43,000 today to $99,000 by 2020.

Selling Employers

Under the Economic Growth and Tax Relief Reconciliation Act of 2001; investment earnings in 529 accounts are no longer subject to federal taxes after withdrawal.

When that tax enhancement took effect this year, financial firms stepped up their marketing of 529 Plans, particularly to companies, seen as rich sources of new enrollments and assets.

Benefits consultants Hewitt Associates, headquartered in Lincolnshire, Ill., found that 19 percent of employers surveyed said they plan to help employees save for college expenses through payroll deduction into 529 plans. An additional 46 percent of employers said they are considering such a move. "That base of 20 or so percent will definitely grow as more employers and employees become aware of 529s," says Robert Greene, a national tuition and financing consultant with TIAA-CREF, the New York-based insurance and financial-services conglomerate.

The employer's role in setting up a 529 plan is to choose carefully from the dozens offered, set up payroll deductions and educate employees on how 529s work. Because there are small yet potentially pivotal differences among the many plans, companies have to study 529 plans carefully. Selecting one plan over another can have a big impact on employees' savings over the long term. (See "Getting Started," below.)