Innovative and effective ways to pay for education

Summary: Morgan Stanley at Work explores choices for funding your education needs from a holistic wealth management perspective—including equity compensation.

Paying for education has become a major investment—one that often requires years of careful planning. Many employers have programs to help fund tuition, often connected to the work you’re doing and based on your tenure with the company, and it’s important to explore all your choices as you plan for expenses. Any personalized financial strategy—whether for your own education costs or when planning to support a loved one—should incorporate your complete financial picture. This includes your company benefits and equity compensation.

It’s a challenge to predict future educational funding needs, but your Executive Services Relationship Manager can help you explore the role your company stock can play in education funding. The right solution may be a mix of tried-and-true tools with innovative, lesser-known strategies. As you begin to explore your options, consider these important factors and possible solutions.

Like most long-range investment strategies, it pays to start early. Popular educational investment choices, such as 529 plans,^a may reward you for thinking ahead and letting your invested funds grow until you’re ready to take tax-free drawdowns to pay for qualified education expenses, including K-12 tuition (up to $10,000 annually). Some states offer an income tax benefit for 529 plan contributions. Similarly, Coverdell Education Savings Accounts (ESAs) allow families to invest in a child’s education by building up tax-deferred earnings in a wide range of investments, eventually making tax-free withdrawals for qualified educational expenses. Exploring such benefits is a good discussion to have with your tax advisor. 

Here’s how time can contribute to the growth of 529 plans: For 2020-21, the cost of a four-year private college averaged $54,880 per year for tuition, fees, room and board, books and supplies, transportation, and other expenses.^b Assuming a hypothetical inflation rate of 4% for college costs,^c if you opened the account when your child was born, you’d need to contribute approximately $906 a month over 20 years to have a high likelihood of being able to meet college costs when needed. (Earning a hypothetical average of 7% per year, your total contributions would be $228,258). But if you wait until they turned 12, you’d need to save $2,156 a month.^d 

It’s a lot of money either way, but grandparents, friends, and other relatives can also contribute to a 529 plan. For 2021, they can generally make annual contributions up to $15,000 a year for a single person and $30,000 for a married couple without triggering the federal gift tax, assuming they didn’t make any other gifts to the same person.^e They can also take advantage of a feature unique to 529 plans that allows them to make five years' worth of contributions at once without triggering the federal gift tax.^f

Also, account owners can change the account’s designated beneficiaries as often as desired, and there’s no age limit or required minimum distributions.^g

A portfolio of zero-coupon municipal bonds is another option to save for college. This type of fixed income security doesn’t pay interest but instead can be bought at a substantial discount to its face value—which it pays in full at maturity, providing a lump sum equal to the initial investment plus imputed interest.

A big potential plus with these bonds: When purchased from a government entity, their interest is often exempt from federal income tax and usually from state and local income tax as well. And if you need a specific amount of funds at a particular date—for example, when paying college tuition—you can work with a financial professional to structure your portfolio so that the bonds mature right before payments would be due.

When there’s a gap between the cost of education and the ability to pay for it, most families reach for student loans—but they’re not always the most reasonable choice, given interest rates. Interest rates on some student loans can exceed 7%^h and, for unsubsidized loans, interest begins accruing the minute the loan is made—even though payments don’t start until after your child graduates. Student loans are generally not dischargeable in bankruptcy proceedings, and lenders can even garnish your Social Security benefits to collect balances owed.

One frequently overlooked strategy is to borrow against your current assets—for example, taking out a line of creditⁱ against vested equity compensation. This can potentially help fund education goals without disrupting long-term investment plans or selling shares at an unfavorable time. Or, if you’re helping a loved one pay for education, you can also consider making a personal loan directly to them. As a borrower, they still bear the responsibility of paying back the loan, which may carry lower interest rates. As the “lender,” you may choose to have the borrower refinance the loan upon leaving school—or, if it’s not paid back, you could deduct it from an inheritance or simply forgive the loan. This is another example of how equity compensation (as part of your assets) can provide a wider range of financial choices—but be sure to consult with a tax advisor on possible tax implications, such as gift taxes.

The best-laid plans must account for potential detours. For example, unexpected career changes or expenses for a new degree, advanced professional training, or continuing education requirements can happen at any time. Or, if you’re planning for your family’s education needs, some students may choose to take a gap year for travel, volunteering, real-world job experience, or studying abroad.

In many circumstances, you may be able to use 529 plan funds tax-free to pay for some of those options or related, qualifying expenses—like books, training programs, or study abroad. Also, there’s no time limit on 529 plans. The funds can stay invested and continue compounding until you need them. But to cover other potential out-of-pocket expenses, consider building an educational cost “safety net” that includes other savings vehicles. Don’t forget to consider your equity compensation and speak to your Executive Services Relationship Manager about additional choices and strategies you can use with your holdings.

Planning for the educational needs of loved ones with special-needs requires special consideration. In addition to traditional educational expenses, you may need funds for occupational, speech, or other therapies. For such expenses, you may want to consider funding a health savings account (HSA) if you are eligible. These accounts allow you to use pretax dollars to offset medical-related expenses.

You can also set up a special-needs trust that benefits the child. Parents and grandparents can also contribute to a special-needs trust, but should be aware of potential tax implications at the time of transfer. A trust and estates attorney with expertise in special needs planning and your tax advisor can help with structuring a special-needs trust.

Another option is to open a custodial account for your child, under the Uniform Transfer to Minors Act (UTMA) or similar rules. Assets in the custodial account can be used to pay expenses associated with the beneficiary, including any non-educational expenses. Because UTMAs may affect financial aid eligibility, it is important to understand the implications of using a UTMA to save for educational expenses.

There is no one-size-fits-all approach to funding your education needs—even if the education you wish to support is your own. Always keep your overall financial well-being and long-term goals in mind, and remember that your equity compensation is a key feature of that big picture.

Your Executive Services Relationship Manager can help you explore your choices and even connect you to options offered through a Morgan Stanley Financial Advisor.^j We can help you find the most effective strategy for managing your unique equity compensation needs as well as your overall wealth.

The source of this Morgan Stanley article, Ways to Pay for College: 529 Plans and More, was originally published in August 2021.

^a529 plans and other products and services discussed in this piece are provided through Morgan Stanley. If you are interested in learning more about Morgan Stanley’s capabilities, please contact the Executive Services Team.

^bTrends in College Pricing and Student Aid: 2020. “Average Estimated Full-Time Undergraduate Budgets (Enrollment-Weighted) by Sector, 2020-21” The College Board. https://research.collegeboard.org/pdf/trends-college-pricing-student-aid-2020.pdf. The results are hypothetical and are for illustrative purposes only, and are not intended to represent future performance of any particular investment. Your actual results may differ. The principal value and investment return of an investment will fluctuate with changes in market conditions, and may be worth more or less than original cost.

^cTrends in College Pricing and Student Aid: 2020. “Published Tuition and Fees over Time” The College Board. Tuition and fees for Private Nonprofit Four-Year Colleges have risen 5.14% per year from 1990-91 to 2020-21.

^d529 Savings vs. Loans Calculator, using a 4% college cost inflation rate, hypothetical 7% annual investment return, and 6% loan interest rate.

^eMorgan Stanley, Ways to Pay for College: 529 Plans and More. 

^fThis assumes that there are no accelerated gifts made by the gift-giver to the same beneficiary during the year of the accelerated gift or the prior four years. Any accelerated gifts made in any of the four years prior to an accelerated gift is made may result in a taxable gift. Any gifts made during the year of the accelerated gift or the four years after may also result in a taxable gift.

^g10 Rules for Superfunding a 529 Plan. Saving for College, https://www.savingforcollege.com/article/10-rules-for-superfunding-a-529-plan

^hAnna Helhoski, “Current Student Loan Interest Rates and How They Work,” Nerdwallet, August 16, 2021. https://www.nerdwallet.com/article/loans/student-loans/student-loan-interest-rates   

ⁱSee disclosure 1 below

^jEligibility requirements may apply and certain products and services are not available to all clients.