529 Plans and more: Innovative and effective ways to pay for education
Morgan Stanley Wealth Management09/02/22
Summary: When it comes to investing for future education costs, there is no one-size-fits-all approach. Consider these important factors and possible solutions.
Paying for education has become a major investment—one that often requires years of careful planning.
One of the most challenging aspects is predicting the future educational funding needs of your loved ones, or yourself—from tuition to housing to extension study programs and more. The right solution may be a mix of tried-and-true tools along with innovative, lesser-known strategies.
As you begin to explore your options, consider these important factors and possible solutions.
Get time on your side
Like most long-range investment strategies, it pays to start early. Educational investing vehicles, such as 529 plans, let 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 annually1). 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.
With the average annual cost for an in-state public college running $26,820,2 allow yourself plenty of time to accumulate savings. Parents, grandparents, friends, and relatives can contribute to a 529 plan. For 2022, they can generally make annual contributions up to $16,000 a year for a single person and $32,000 for a married couple without triggering the federal gift tax, assuming they didn’t make any other gifts to the same person. 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.3
Zero in on zero-coupon muni bonds
A portfolio of zero-coupon municipal bonds can be another way to save for college. This type of fixed income security does not 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 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.
Plan for the road less traveled
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. If you’re planning for your family’s education, some students may choose to take a gap year for travel, volunteering, or real-world job experience.
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. Additionally, the funds can stay invested and continue compounding until you need them.
To cover other potential out-of-pocket expenses not eligible for tax-free 529 plan account withdrawals, such as tutoring and test preparation courses, build an educational cost “safety net,” which may include other savings vehicles and an alternative source of credit.
Think about your own educational needs
Sometimes the education you want to fund is your own. If you’re planning to pursue a degree, it may be a good idea to name yourself the beneficiary of a 529 plan and use those funds to pay for your education. There are no age or time restrictions imposed by IRC Section 529 but check if the 529 plan under consideration has any such limitations.
Consider your financial big picture
Always keep your overall financial well-being in mind, especially if you are balancing multiple financial goals. There is no one-size-fits-all approach to funding your education needs, but a solid first step is to learn about the tools and strategies available to help get you there. If you decide you want professional guidance, consider a financial advisor, who can help identify a plan that works for your individual circumstances.
The source of this article, 529 Plans and More: Innovative and Effective Ways to Pay for Education, was originally published on August 5, 2022. The original content has been modified for E*TRADE from Morgan Stanley audiences.
- Assets can accumulate and be withdrawn federal income tax-free only if they are used to pay for qualified expenses. Qualified expenses include tuition, fees, room and board, books and supplies at virtually any accredited post-secondary school. Effective January 1, 2018, the definition of qualified education expenses expanded to include tuition for K-12 schools, as a result of the 2017 Tax Cuts and Jobs Act. The revised tax law limits qualified 529 withdrawals for eligible K-12 tuition to $10,000 per beneficiary per year and state tax treatment will vary on a state by state basis. The state tax treatment of K-12 withdrawals is under review by many states. Account owners should consult with a qualified tax advisor prior to making such withdrawals as they may be subject to adverse tax consequences. Earnings on non-qualified distributions will be subject to income tax and a 10% federal income tax penalty. Note, the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 signed into law December 20, 2019, expanded the definition of qualified higher education expenses for federal income tax purposes to include certain costs associated with qualifying apprenticeship programs and up to $10,000 (lifetime limit per individual) in amounts paid towards qualified student loans of the 529 plan designated beneficiary (or such beneficiary’s sibling). Note, however, using 529 plan distributions to repay qualified student loans may impact the deductible of student loan interest. This provision applies to 529 plan distributions made after December 31, 2018. The state tax treatment of 529 plans (including the state tax treatment of contributions and distributions) may be different from the federal tax treatment and may vary based on the particular 529 plan in which you participate and your state of residence. If the applicable state tax law does not conform with the federal tax law, 529 plan distributions used to pay certain expenses, such as principal and interest on qualified student loans and/or qualifying apprenticeship costs, may not be considered qualified expenses for state tax purposes and may result in adverse state tax consequences to the account owner or designated beneficiary.
- College Board, Trends in College Pricing and Student Aid 2021
- This 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.
How can E*TRADE help?
Work with a Morgan Stanley Financial Advisor
Bring your future into focus
Now that E*TRADE and Morgan Stanley have joined forces, you may be eligible to work with a Morgan Stanley Financial Advisor to gain access to a broader array of investment solutions, including 529 plans.
Save for a child’s education
Tax-free withdrawals for qualified educational expenses, such as tuition and books.
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