Benefits: Looking for the Next 401(k)?
Stephanie Shaw, the vice-president of human resources for Caminus Corp., an $80-million software company based in New York City, made history recently. Well, OK, human-resources history. Last April, under her direction, Caminus became one of the first small companies in the country to offer a 529 plan -- commonly referred to as a college-savings account -- as an employee benefit.
So far, of the approximately 500 employees at Caminus, 25 have signed up. Every pay period Caminus deducts an amount, designated by the employees, from their post-tax paycheck. That amount -- which must be at least $50 a month -- goes directly into a 529 account that the company has set up. (Caminus employees can mix and match among six investment options, varying from aggressive to conservative.) The investment earnings accrue tax-free in the account, and money can be withdrawn without penalty so long as the withdrawal is spent on college tuition or other qualified higher-education expenses, including room and board and books.
The plan is essentially an enhanced savings account for college, except that instead of relying on self-discipline to set aside money, employees can rely on their company to impose the discipline on them automatically, paycheck by paycheck. And the return is enhanced because most 529 plans offer investment options with higher interest rates than those offered by a standard savings account.
So if you're an employer, what's not to like about 529 plans? Is there even a downside to offering your employees yet another benefit, especially one that -- isn't it precious? -- helps your staffers save for their children's education?
On the surface, 529 plans appear to be a terrific benefit. But dig a little deeper, and you might conclude that offering them may not yet be worth your while.
To begin with, all consumers have access to a 529 plan. A 401(k) plan, by contrast, is an investment vehicle that's available only through employers. So in opting to avoid 529 plans, it's not as though you'd be denying your employees something to which they'd otherwise have no access.
Second, the administration of 529 plans has dozens of potential pitfalls, especially if your company has employees in multiple states. Caminus, for example, has staffers in three states: New York, Texas, and Washington. That put Shaw in a tricky situation.
Back in 1996, when Congress added Section 529 to the tax code, it left the administration of 529 plans up to individual states. Indeed, prior to 1996, several states ran their own tuition-savings programs, many of which gave residents a break on state taxes. Left to their own devices, states chose their own 529-plan providers. Ohio, for example, chose Putnam Investments, Rhode Island chose Alliance Capital, and New York chose TIAA-CREF.
The problem Shaw faced was that many of her employees lived in either New York or Texas. Texas did not yet have a plan, but New York's plan allowed residents to potentially save thousands in state-tax deductions. However, if Caminus offered the New York plan, the company risked discriminating against the company's non-New York residents. But if it offered a non-New York plan, then employees who lived in New York stood to lose the tax benefit. What was she to do?
In the end Shaw chose to offer the Rhode Island plan that was administered by Alliance Capital. Her reasoning: the majority of Caminus employees were not New York State residents. It would not have been fair to choose a plan that gave fewer than half of the company's employees a state-tax break. Shaw thought that it was much fairer to choose a neutral state where all Caminus employees -- none of whom are Rhode Island residents -- received equal treatment.
Plus, says Shaw, "we felt the features of the Rhode Island plan were better for our overall population." Those provisions included: no minimum waiting period before a qualified withdrawal could be made, whereas in New York an employee had to have been in the plan for at least three years; a higher lifetime contribution limit than the New York plan ($265,000 versus $235,000); and more investment options (six for Alliance versus TIAA-CREF's four).
There was also the trust factor: Shaw was comfortable working with DB Alex. Brown, her vendor for Caminus's employee stock ownership plan. So when the advisers suggested Alliance Capital's 529 plan, they had Shaw's ear. She knew that administering the program would be less of a hassle, since she wouldn't have to work out the kinks of a new vendor relationship.
Still, Shaw did her homework before presenting the Alliance plan to Caminus's workforce. She sent out dozens of E-mail messages and conducted meetings at each company location, educating employees on three key facets of 529 plans. First, if the employees preferred, they could participate in the New York State plan -- or any state's plan -- on their own. (With the exception of Kentucky, Louisiana, and New Jersey, all states welcome nonresidents as participants.) Second, employees might benefit from enrolling in their home state's plan, if their resident plans offered state-tax deductions. Third, employees could participate in more than one 529 plan, depending on the provisions in their individual states.
The biggest question that employees had was, What would happen to their money if they left Caminus? The answer? They could either continue managing the account individually or roll over the funds into another 529 plan without penalty.
The possibility of rolling funds over once a year without penalty is generally offered by most 529 plans. However, depending on what types of funds that employees invest in, there may be other penalties for early withdrawals. Before you sign your company up for a 529 plan, be sure to determine whether employees can freely transfer to new plans.
Chances are, though, that your employees won't start asking about 529 plans for at least a year. A Harris Interactive study conducted in August 2002 reported that only 40% of working Americans are familiar with 529 plans at all, let alone as a company benefit. And 95% of those surveyed said that their employers are not yet offering the plans.
So far, the number of employers that are offering 529 plans through a payroll deduction is still small, though hard numbers are difficult to find. TIAA-CREF, which handles more state plans (a total of 13) than any other fund manager, estimates that 4,500 of its corporate clients offered 529 plans as of October 2002. That's up 80% from October 2001, when 2,500 TIAA-CREF companies offered the same perk. But although 4,500 is a respectable number of companies -- especially considering how young 529 plans are -- it's a total that's hardly astonishing.
Still, all the numbers point to increases in 529 awareness and assets. Cerulli Associates, a research firm in Boston, predicts that the total college-savings market will grow to $51 billion by 2006. That growth is impressive, considering that the market was $9.1 billion in 2001, and staggering when you consider that it was $144 million in 1998. But the 529 market is minuscule compared with the $1.64-trillion 401(k) market.
Why then should you consider 529 plans right now? Mainly because the sales calls will be coming soon, from both your current 401(k) provider and elsewhere. "Even though the programs are governed by the states, all the funds that are branding themselves as national plans are having success," says Arman Rousta, CEO of 401kid, a consultancy in New York City that specializes in financial planning for college. "Fidelity and Putnam have been selling their state plans nationally to corporate clients."
Indeed, 529s are already prominent on the big-business landscape. TIAA-CREF administers plans for Kellogg, J.P. Morgan Chase, and Micron Technology. Other providers didn't name names but reported that they were in serious discussions with big-name customers. "Almost every Fortune 500 company has brought this up with their boards," confirms Rousta, who tracks the industry obsessively. He adds that in the financial-services industry, the "land grab" to sell plans to businesses is so intense that providers are "taking advantage of the lack of knowledge" among HR directors about 529-plan nuances.
But why is the "land grab" occurring now? Two reasons. First, in 2001, Congress changed the nature of 529 plans from tax-deferred to tax-free. Second, the financial-services industry began pushing 529 plans as the market reeled and investors sought safer investment options. "It's tough selling mutual funds and other things based on just performance, so it's appealing to sell something like this, which also has the emotional appeal of sending your kid to college," explains TIAA-CREF vice-president Tim Lane.
You and your employees will survive the coming sales onslaught if you remember that a 529 plan is just an investment vehicle, nothing more. Similar plans are available to all consumers. So don't sweat the sales pitch when it comes. And don't feel as though you'll be missing the boat if you -- or your employees -- opt not to participate.
Nine things to consider about 529s
Here's a list of questions a company owner needs to ponder before agreeing to offer 529 plans as a benefit.
1. Do most of your employees have children?
2. If so, have they gone about setting up their own 529 accounts, or would your company's presentation of a 529 plan be the first they've heard of it?
3. Should you enroll with your current 401(k) provider, or should you seek out whichever provider manages the plan for your home state?
4. If you have employees in multiple states, which state's 529 plan should you offer?
5. Are earnings subject to state taxes upon withdrawal?
6. What are the contribution limits and minimums?
7. Is there a minimum waiting period before making qualified withdrawals?
8. Are the investment options varied, or are they mostly slow growth?
9. If employees leave your company, will they be able to transfer funds to another 529 plan without penalty?
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