The Latest Corporate Benefit: the 529 Plan

The 529 plan is coming to the workplace.

To make it easier for employees to save money for college, more companies are adding 529-plan perks to workplace-benefits packages. Some employers allow workers to fund these college-savings vehicles automatically via payroll. Others kick in matching contributions. The goal is to make saving for college akin to saving for retirement by providing some of the same incentives that encourage workers to contribute to 401(k) accounts.

“We have absolutely seen an uptick in both interest and numbers of employers offering college-savings plans in the workplace, says Kris Spazafumo, a vice president at American Funds, whose CollegeAmerica 529 plan is the country’s largest by assets under management, according to Morningstar.

Although 529 perks aren’t yet a common employee benefit, CollegeAmerica says its corporate-sponsored accounts have been expanding in number at a rate of about 5% annually over the past five years. Similarly, Ascensus Inc., which provides administrative services for more than 30 529 plans across the U.S., says the number of employers participating in payroll direct deposits across the plans it manages rose to more than 12,000 last year from just over 11,000 in 2014.

As 529 benefits make their way into the workplace, here are a few things employees should consider:

Tax complications

Many consider 529 plans to be valuable college-savings tools because contributions are allowed to grow tax-free, and earnings can be withdrawn free of federal income tax if used to pay for qualified education expenses. In addition, most states offer tax deductions or credits in exchange for 529 contributions.

When people open 529 accounts on their own, they can choose from almost any of the direct-sold plans available nationwide. If they sign up through work, they may be limited to a specific plan or plans that their employer is promoting. And depending on where an employee lives, that could mean leaving some valuable tax breaks on the table.

Here’s why: Twenty-seven states and the District of Columbia offer deductions or credits only on contributions residents make to theirin-state 529 plan. So if an employer is promoting a 529 plan sponsored by a state other than the one in which the worker lives, the worker may not qualify for those tax incentives.

L.L. Bean Inc. last October began offering automatic payroll deposits into NextGen, the 529 plan sponsored by Maine. The Freeport, Maine-based retailer says it chose that plan because three-quarters of its employees live in Maine, and the state gives residents who enroll in NextGen a 50% match on contributions up to $300 annually, as well as a one-time $100 grant for six regular automated contributions.

The 24% of L.L. Bean’s employees who live outside of Maine can contribute to NextGen via payroll, but they aren’t eligible for the matches and grants that make the plan so attractive to Maine residents.

“It is important for employees to understand how [their] state plan and its benefits compare to the plan chosen by the employer,” says Mark Cortazzo, a financial planner at Macro Consulting Group in Parsippany N.J. Still, he says, the convenience and ease of payroll contributions may outweigh all other considerations, especially if it means the employee is more likely to save.

(L.L. Bean says it will consider broadening its 529 benefits to include out-of-state plans and a company match.)

Company matches give rise to another tax issue that 529 savers need to consider. While contributions to 401(k) retirement accounts are tax deferred, 529 contributions are made with after-tax dollars. That means workers who contribute to employer-sponsored 529s will owe annual income tax on any employer contributions or matches.

Mr. Cortazzo says the added tax bill is well worth the benefit. Not only do employer matches help pad a college-savings account, workers may be able to withdraw the funds in an emergency because only 529 earnings are subject to taxes and penalties if not used for education-related expenses, he says.

Some companies, such as San Francisco-based software firm inDinero, rely on financial advisers to help them set up their 529 offerings. “We don’t have a fully built out HR department,” says Amy Wolfenberger, the firm’s client-communications manager, in explaining why the company used an adviser to roll out 529 benefits to its staff in January.

If an employer has taken this approach, be aware: Some 529 plans are sold only through advisers, who get commissions on the funds they promote. These plans often have higher cost structures, including annual sales charges, than direct-sold plans, says Andrea Feirstein,founder of New York-based AKF Consulting Group, which advises state governments on 529 plans. Employees need to evaluate whether the extra costs are worth it, she says.

“You’re paying for the services and expertise offered by the financial adviser,” says Morningstar analyst Leo Acheson, adding that adviser-sold plans tend to offer more “granular” investment options, such as high-yield bonds, whereas direct-sold plans tend to be more broad..

Customized advice

Some employers don’t want to promote a specific 529 plan or plans, so they use third-party companies such as LEAF College Savings LLC and GiftofCollege.com to facilitate payroll deposits and matching contributions into 529s that employees choose on their own. Some of these services even help users pick a plan.

Kaufman Rossin, a Miami-based accounting firm with offices in several other major cities, is using one of these services, Gradvisor, to roll out 529-plan benefits to its 335 employees later this year. “A majority of our people are in south Florida, but I wanted to make [the college-savings plans] available to all our employees,” says Joy Batteen, a human-resources director at the firm.

Employees can go to Gradvisor’s website for customized advice on which direct-sold 529s might best suit their needs and how much to save per paycheck. They also can track their investments, adjust contributions and speak with a financial adviser for no additional charge.

Still, some financial experts say it may take features such as automatic enrollment for usage of 529 plans to approach that of 401(k)s.

Enrollment needs to be as simple and automatic as possible, saysMichal Grinstein-Weiss, a professor at Washington University in St. Louis, who is researching employer-sponsored financial-wellness programs.