A Short Course in College Savings Plans

    As the plans gain widespread acceptance, they are increasingly becoming a must-have benefit for any company looking to offer a competitive benefits program. If you wish to attract and retain key employees, you should consider offering this program. As with any new benefit, however, there are pitfalls that informed human resource executives should be aware of.

    It is, of course, easy to understand why the plans are so inviting. College costs are fast becoming out of reach for the average household. Studies have shown that college costs have risen at twice the rate of inflation for most of the past two decades. According to the College Board’s annual survey “Trends in College Pricing,” by the time a child born today enters college in the year 2020, the cost of a four-year education at a public university will be more than $85,000. The price at a private institution: a staggering $225,000.

    To help offset these expenses, the federal government created Section 529 plans in 1996. Though they have evolved since then, the basic premise is to provide a tax-advantaged plan to help people save money for college expenses. In addition, there is an estate-tax benefit that removes the assets from the donor’s estate and allows donors to accelerate the use of the annual gift-tax exclusion. The Economic Growth and Tax Relief Reconciliation Act of 2001 has made these programs even more attractive by allowing qualified withdrawals to be taken completely free of federal income taxes when used to pay for qualified education expenses—at least through 2010. These expenses include tuition, room and board, books and fees, and any other required student expenses at any accredited college or university in the United States. Previously, withdrawals were taxed at the beneficiary’s rate. According to the College Savings Plans Network, an affiliate of the National Association of State Treasurers, more than 3 million children across the country are enrolled in a state college-savings plan. Assets in these programs now exceed $18.3 billion.

    The reality can be quite different. The plans, in fact, aren’t all the same. The federal government authorized individual states to oversee these programs. Subsequently, there are now about 50 different programs available, all with varying features, capabilities, and tax benefits. Some states offer state tax deductions for residents using their own state’s plan. In many states there is no advantage to using the in-state program. Generally, an employer should consider both in-state and out-of-state plans. Many investment firms limit the number of programs that their representatives can work with. Most mutual fund companies and 401(k) providers that offer 529 plans will work only with their own programs, regardless of state-specific tax benefits. A good question to ask is: “Am I being offered the best plan for my company or simply the best—or only—plan that a vendor can sell?” To find out, consider the following factors:

    Coverage. Can the plan provide all of the available tax benefits to all of your employees? There are certain states that offer an additional tax credit for residents contributing to their home state’s plan. Not considering the state-specific tax benefits can be unfair to employees who could qualify for such benefits and can potentially expose your company to liability. If your vendor cannot or will not support these plans, be sure to find a vendor that will.

    Practicality. Does the plan offer low monthly minimums for rank-and-file employees as well as high maximum contributions for wealthier employees who want to take advantage of the estate-tax benefits? Some plans offer minimum contributions as low as $15, while others require $500 up front or $50 per fund per month. As for the maximums, there are some plans that give people the ability to invest up to $300,000, while others cut off donors when the account reaches $100,000. This can have significant impacts on covering education costs and managing the estate planning.

    Corporate Ease of Use. Not all plans have payroll-deduction or direct-deposit capabilities. Even if they do, some have Internet enrollment features that make the plan easier to administer. Most important, confirm what your broker or adviser is willing to do for you. Will they handle all of the paperwork? Will they support multiple plans? Will they answer employee questions so you do not have to? If the answer to any of these is no, then your “no-cost” plan will start to incur the costs associated with your time and effort.

    Investment Flexibility. How many investment options does the plan provide? Many plans still provide just one age-based investment option—“set it and forget it.” This option allocates the donor’s money across a variety of funds according to the beneficiary’s age. When the child is very young, most of the money sits in equity mutual funds. As the child ages, the portfolio is changed until it invests primarily in money market and bond funds when the beneficiary is 16 or older. This may not be ideal, especially if the intention is to use the money for the child’s graduate school or the donor’s own education years from now.

    To address this lack of flexibility, some plans offer static portfolios that remain the same no matter what the beneficiary’s age. The latest features allow donors to select individual funds and truly customize their portfolios, including more conservative fixed-income options. In today’s nervous investment environment, participants are increasingly seeking greater fixed-income or bond-fund choices. The extent of these offerings varies greatly by program.

    Investment Pricing. Some plans are similar to 401(k) plans. They provide pricing discounts that waive certain fees and/or sales charges and surrender charges for employees if the plan is offered through the employer. In some cases, the differences in expense ratios, and subsequently the returns on the investments, can be quite dramatic. Again, this is a critical issue when asking whether this is the best plan for your company or just the best plan a vendor can sell. Also, many fund companies try to hide their newer funds with higher expense ratios in these programs so they can quickly build up more assets.

    Investment Quality. True, most investments into these programs are placed into age-based asset-allocation portfolios. So, in theory, over time the performance records of these portfolios should start to mirror one another (less expenses, of course). However, you should lift up the hood on what employees will be investing in. Ironically, these programs are marketed on the basis of their tax advantages and no-cost, low-maintenance administrative requirements for the employer, but the underlying investments are often downplayed. Many programs offer portfolios with widely overlapping funds in them, thus defeating the purpose of a diversified asset-allocation portfolio. Likewise, due diligence should consider any overlap with the existing 401(k) investment choices in order to further reduce any overlap.

    Support. Just as some mutual fund companies may not have the experience or back-office capabilities to be the vendor for your 401(k) plan, the same can be said of 529 plans. For example, one company that sponsors multiple state plans has an enrollment staff of only three people, while another popular provider has a participant call center with a staff that can be counted on one hand. More important, your vendor and/or adviser should be able to provide education and answer questions about 529 plans and other college-savings vehicles like UGMA/UTMA accounts and Coverdell Education Savings Accounts (formerly Education IRAs). Ongoing support should also include separate estate-planning education for employees concerned about the unique “gifting” guidelines offered in a 529 plan, along with awareness of and enrollment assistance for shopper-loyalty programs such as Upromise and Babymint.

    Before rolling out the program, survey your employees to gauge the interest level and to assess the impact on 401(k) contributions that a competing savings program might have on your company. Inquire about how ex-employee 529 plans will be handled. These programs are highly portable benefits that can travel with employees long after they leave the service of your company.

    A properly administered 529 plan can achieve ease of administration and high participation levels at no cost to the employer. However, chances are that the vendor at your door can offer only one or two plans. As the plans change, you may find that you purchased a product, not an ongoing solution. An ill-conceived and improperly executed program can lead to a plan that is “no-participation” instead of no-cost, no-maintenance, and no-liability. Remember, these plans are still relatively new and continue to change and evolve. In the last 12 months, 529 programs have improved dramatically in terms of the investment selections, data, and number of choices available to employers and employees. Because this trend should continue, employers would do well to look for a flexible solution that works for them.

    If you find yourself overwhelmed by the choices and sheer volume of information, an independent adviser may be able to help. An independent adviser can also coordinate the implementation and education processes and make the program(s) more manageable.

Workforce, September 2002, pp. 50-55 -- Subscribe Now!