Benefits: Looking for the Next 401(k)?

A tax-free savings plan for college sounds like a great perk, but take a close look at the fine print before signing on.

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Benefits

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 The investment earnings accrue tax-free in the account, and money can be withdrawn without penalty so long as the withdrawal is spent on college tuition or other qualified higher-education expenses, including room and board and books.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.

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