Funding your child's education with equity compensation

Morgan Stanley at Work

 09/05/23

Helping pay for college isn’t just about footing tuition bills. It’s also a way to pass on your values about the importance of education and help your loved one(s) avoid the debt that can follow them long after graduation.

But the price tag can be steep. For the 2022-2023 school year, the costs for a four-year private college averaged $57,570 per year for tuition, fees, room and board, books and supplies, transportation and other expenses.1 Assuming a college-cost inflation rate of 6%, a parent may need $425,500 in 2031 to pay college expenses for today’s 9-year-old.2 And that’s for just one child. With costs like that, it’s never too early to start planning.

When funding education costs, start by considering your various sources of income and how they might contribute to your plan—including your equity compensation. The first step is understanding your equity compensation holdings, including the type(s) of equity awards you’ve been granted, vesting schedules, the tax consequences associated with the sale of fully vested shares and the exercise of stock options, and more. Check your company’s plan documents and your equity award grant agreements for details on your specific awards.

Once you have a handle on your awards, you can start thinking about how to put them to work. Different types of education savings accounts need to be treated differently, as some can be funded directly with stocks while others are cash-only accounts. Let’s explore three popular education funding options and some key considerations to keep in mind when using equity compensation to contribute.

 

Equity compensation considerations

1. 529 Plan

529 plans are state-specific tax-advantaged accounts that can be used to cover the account beneficiary’s future qualified education expenses, which might include tuition, room and board, books, and other supplies. These accounts can only be funded with cash contributions, not stock or other assets. But you can, if desired, fund a 529 plan using the proceeds from the sale of any shares resulting from vesting or exercise of the underlying equity compensation.

If you are coming into a large equity compensation payout in one year, you can make a “5-year election” into a 529 plan and contribute a larger cash lump sum in one year but treat the contribution as if it were made across five years for federal gift tax purposes. Contribution limits and state tax treatment will vary by state.

2. Coverdell Education Savings Account (CESA)

Formerly known as an education IRA, this tax-advantaged trust or custodial account only accepts cash contributions, not stock or other assets. But similar to 529 plans, you can fund these accounts using the proceeds from the sale of any shares resulting from the vesting or exercise of equity compensation.

2. Uniform Transfers to Minors Act (UTMA) and Uniform Gifts to Minors Act (UGMA) Accounts

UTMA and UGMA accounts are custodial accounts used to hold and protect assets for minors until they reach age of majority in their state. These accounts may be funded with stocks, including holdings resulting from the vesting or exercise of equity compensation, plus bonds and mutual fund investments. UTMA and UGMA accounts will not accept unexercised stock options, unvested restricted stock or Restricted Stock Units; all equity compensation contributions must be in fully vested company shares.

The bottom line

There are several ways to use your equity compensation for education expense saving purposes. You can use share sale proceeds to contribute to an education savings account, hold onto the stock in an investment account to use for education expenses in the future, or transfer stock resulting from the vesting or exercise of equity compensation into a UTMA/UGMA custodial account.

And you don’t need to choose just one option. A blended approach may be useful to take advantage of different features and potential tax benefits. You should consult with financial and tax professionals along the way to help you create a strategy that’s tailored to your needs and financial situation, as some saving strategies may have implications on your taxes and financial aid eligibility.

 

1. "Trends in College Pricing and Student Aid 2022," The College Board.

2. Projected college costs in 2031 include 6% annual tuition inflation rate: https://bigfuture.collegeboard.org/pay-for-college/college-costs/college-costs-calculator