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Mitchell Langbert

Funding Vehicles That Haul the College Tuition Load

How companies can help employees pay college costs.

August 18, 2011
by Mitchell Langbert, PhD

In his book on the growing economic woes of higher education, Going Broke by Degree (Richard Vedder, Going Broke by Degree: Why College Costs Too Much. Washington, DC: AEI Press, 2004.), Richard Vedder shows that, since the 19th century, higher education costs have increased more rapidly than general inflation. He also shows that declining productivity in the higher education field is the reason. It takes more resources to educate students now than in the past and there is no evidence that students are better educated even though in inflation-adjusted terms their educations cost more. Perhaps the best college education funding plan would be for the accounting profession to educate educators about cost control and staffing efficiencies. Until then, saving for college will be a challenge for accountants and most everyone else.

Since the 2004 publication of Vedder's book, tuition has continued to escalate. According to the National Council for Education Statistics in the 2003-2004 school year the average private college undergraduate paid $24,624 in total tuition, room and board while in 2009-2010 he paid $34,939 in not-for-profit colleges. Student aid in 2007-2008 averaged $9,100. Because of rising costs, tuition assistance plans for active employees have been important. In 2004, 83.5 percent of employed participants in formal work-related courses received some form of tuition assistance from their employer. As well, employers are increasingly interested in providing grants, scholarships and payroll-based section 529 plans for their employees' children. There are also Coverdell Education Savings Accounts (ESAs) and tax credits available to some employees.

Grant and Scholarship Plans

Nancy Hatch Woodward's 2005 HR Magazine article "Helping Workers Pay College Costs" (Nancy Hatch Woodward, "Helping Workers Pay College Costs," HR Magazine 50: 8, August 2005.) points out that one of the chief reasons that employers provide scholarships and other funding programs for employees' children is employee retention. As well, scholarships generate positive publicity and good will. Employers can set up either taxable or nontaxable programs. Setting up a taxable award is the simplest approach. Taxable programs allow plan sponsors flexibility and have low administrative costs. The down side is that the grant is reported on the recipient's W-2.

To set up a tax-free program the sponsor must first set up a 501(c)(3) entity or hire an established foundation. Contributions are tax deductible. But to achieve tax exemption the employees that are eligible for the award or scholarship must constitute a legitimate charitable class. The scholarships cannot require teaching, research or other services by the student to the employer. Ways to achieve this are to establish an independent selection committee, not require that the grant recipients study any particular field and avoid using the scholarship program as an inducement to continued employment. The last point can get sticky because most firms are not interested in providing scholarships when an employee has terminated her employment. But ending the scholarship for that reason could eliminate its qualification for tax exemption. Also, a maximum of 25 percent of eligible students who apply or 10 percent of those who are eligible can receive grants.

The chief advantage to using an established foundation or other third party is that the possibility of being accused of bias or other lack of integrity in selecting recipients is eliminated. Fees can be on a percentage or flat fee basis or a combination. Percentages range from four percent to 18 percent, depending on the scholarship amounts.

About half of sponsors use financial need as a criterion. Eligible income levels can be capped at say $150,000. Also, level or position in the firm can serve as a cap, such as limiting benefits to managers or below. Also, employers are allowed to limit eligibility with up to a three years' service requirement. Amounts of grants range from $500 to over $3,000 per student.

Payroll-Based Section 529 Plans

In a 2002 article in Benefits Quarterly (Carol S. Hershey and Marjorie Martin, "Should Employers Provide Section 529 Plans to Employees?" Benefits Quarterly, Fourth Quarter 2002, 56-61.) Carol S. Hershey and Marjorie Martin describe a section 529 plan as similar to a Roth IRA. Contributions are made post-tax but earnings accumulate tax free; distributions are also federal tax free if the distributions are used to pay for qualified higher education expenses. State tax is slightly more complicated because only a few states such as Pennsylvania, Arizona, Maine and Kansas have parity for tax exemption in other states. Thirty-four states and the District of Columbia offer a deduction for plans that their own state sponsors, but not for plans sponsored by other states.

Firms could contribute to 529 plans that vest upon the child's reaching age 18, provided the child attends college, but few do. As long as there is no constructive receipt (such as a risk of forfeiture due to termination of employment), there would be no income to the employee, but the distribution would be taxable to the employee.

Hershey and Martin note that many employers prefer not to offer 529 plans because of the state-taxation issue. Offering such plans merely means serving as a conduit for contributions to one of the state plans. It does not appear that Employee Retirement Income Security Act (ERISA) applies to such plans because they just involve payroll transfers to third-parties. However, the Fair Labor Standards Act (FLSA) may apply so that employers must not be slow in transferring the employees' deductions to the plan administrator. If employers offer a single plan, for employees in most of the states, other than the state in which the plan is domiciled, employee contributions will not be tax deductible.

Hershey and Martin argue that there are three possible strategies for employers to consider:

  1. The minimal strategy in which the employer merely provides information on Internet sites.
  2. The middle-of-the-road strategy in which a single state plan is offered and favorable tax treatment is limited to the host state.
  3. The proactive approach in which firms provide an employer match, multiple state plans and investment information. Under the proactive approach firms might prefer to hire a third party administrator or investment manager.

Section 529 plans are generally state-based, but there is an Independent 529 Plan that is sponsored by over 270 private colleges in various states. There are two kinds of section 529 plans. Prepaid tuition plans lock in future tuition costs by having the employee purchase education units. For instance, the Texas Tuition Promise Fund allows you to lock in the cost of undergraduate tuition and so protect against future tuition inflation by purchasing tuition units. The units can be "all-Texas," "four-year," and "Texas Junior College." Since college tuition increases seem to have been more reliable than recent financial market returns, this might be a good bet. In addition, the Texas College Savings Plan offers age-based portfolios that are similar to a Roth individual retirement account (IRA). Like many state plans, the Texas plan has a limit, in Texas' case $320,000 per beneficiary. Every state offers section 529 plans that are comparable to Texas' in general, but differ in plan design details.

Writing in The CPA Journal (Peter D. Lucindo. Section 529 Qualified Tuition Program. The CPA Journal. April 2010, 48-51.), Peter D. Lucindo points out that qualified higher education expenses include tuition, fees, books, supplies, computer technology, Internet Access and room and board. Recent bills in Congress include extending the Savers' Tax Credit to section 529 plans (which would provide a $1,000 tax credit to single tax payers and $2,000 for married) for single taxpayers with below $27,750 in income and 55,500 for married taxpayers.

Other Programs

Besides grant and scholarship programs and section 529 payroll deductions, employees can set up custodial accounts, according to Finaid.org. These include trusts under the Uniform Gift to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA). The money is irrevocably gifted to the minor. For purposes of financial aid the account would be treated as part of the student's assets unless the money is transferred to a section 529 plan, in which case it is considered a parental asset.

Coverdell Education Savings Accounts (Coverdell ESAs) provide for saving up to $2,000 per year. They function like Roth IRAs. Until 2002 they were called Education IRAs. Distributions from a Coverdell ESA are excluded from the child’s income to the extent that they are used to pay the child’s qualified education expenses. The balance in the account generally must be distributed by 30 days after the child reaches age 30 or dies. Distributions to the child that are not used to pay qualified education expenses are included in his or her gross income.

In addition to these funding vehicles, the Internal Revenue Code offers a lifetime learning credit of up to $2,000 per return with income limits in 2011 of $122,000 in adjusted gross income for married taxpayers filing jointly and $61,000 for single persons. The American opportunity credit is up to $2,500 per eligible student with an income limit in 2011 of $180,000 if married, $90,000 if single.

Conclusion

None of the funding programs are stellar for either firms or their employees. The best for employees would seem to be the Section 529 plans and, of course, grants. But grants must be limited to no more than 10 percent of eligible students or 25 percent of those who apply. Section 529 plans are complicated by states' reluctance to provide tax parity to other state plans.

The problems underlying college tuition increases are economic and managerial. In a free market, the rapid escalation of tuition would not likely persist. Perhaps the best college tuition plan would be one in which private industry makes a proactive contribution to colleges with respect to cutting costs, eliminating wastes and, most important of all, to dealing with the intractable political resistance of empire-building administrators and self-indulgent tenured faculty. A careful reading of Vedder's book is a good place to start.

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Mitchell Langbert, PhD, is an associate professor at Brooklyn College. Widely published on the subject of human resource management, Langbert has consulted and served as an expert witness.

* DISCLOSURE: Readers should assume that all views expressed in this column are the author's unless otherwise noted and does not necessarily reflect the views of the AICPA or the AICPA Career Insider.