529 Plans and more: Innovative and effective ways to pay for education
Morgan Stanley Wealth Management09/02/22
A 529 plan is a great way to invest for future education costs, but there are also other options to raise the funds you need.
Education has outgrown school. What do we mean by that? Even a generation ago, most people tended to think of schooling as finite stages of growing up. Yes, there were costs involved, but like the cuts and scrapes of childhood, they would heal and become a distant memory.
Today, we talk about education as a lifelong journey. It starts with school, but it never really ends. The associated costs have also matured and now resemble longer-term budget items, such as housing and health care. Paying for education has become a major investment—one that often requires years of careful planning. As the costs keep rising, you should approach funding educational expenses, such as tuition, extension programs and advanced professional training, like any other kind of investment that needs a strategy built for your specific needs.
One of the most challenging aspects of crafting such plans is predicting the future educational funding needs for your loved ones, or yourself. The right solution may be a mix of tried-and-true tools with innovative, lesser-known strategies to help plan for the uncertainty.
Here are some strategies that may help cover today’s expected and sometimes unexpected, educational costs.
Take Advantage of 529 Tax-advantages
Named after Section 529 of the Internal Revenue Code, a 529 plan is a tax-advantaged way to invest for future education expenses. There are various advantages of investing in a 529 plan as well as planning strategies to be aware of. Earnings in a 529 plan grow tax-deferred, and withdrawals are generally exempt from federal and state income taxes if the funds are used for qualified education expenses including tuition, fees, room and board and supplies.3 Many states also offer a state income tax deduction or credit for contributions to 529 accounts but may limit the availability of such credit or deduction to only those contributions made to that state’s sponsored 529 plan.
529 plans offer gift tax and accelerated contributions opportunities to gift potentially significant amounts from your estate while still retaining control of the assets as the account owner. For federal gift and estate tax purposes, your 529 plan contribution is considered a completed gift to the beneficiary and generally qualifies for the 2023 annual gift tax exclusion of $17,000 ($34,000 for married couples), enabling you to make contributions without being subject to the federal gift tax.
Additionally, for 2023, one can frontload their contribution to as high as $85,000 in one year per account/beneficiary ($170,000 for married couples) and elect to take that frontloaded contribution into account for purposes of the annual gift tax exclusion over a five-year period.1 The five-year gifting election is a feature unique to 529 plans and accelerated contributions increase the time that assets can potentially grow tax-free, boosting the potential account growth.
Zero in on zero-coupon muni bonds
A portfolio of zero-coupon municipal bonds can be a smart way at times 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 imputed interest. A big 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 – a Financial Advisor can structure your portfolio so that the bonds mature right before payments would be due.
Make smart debt choices
When a gap looms between the cost of education and the ability to pay when due, most families reach for student loans by default. But they’re not always the right option. Interest rates on some student loans can exceed 7%; what’s more, for unsubsidized loans, that rate begins accruing the minute the loan is made, even though payments don’t start until after your child graduates.
Many parents understandably want their children to have some "skin in the game"—and student loans certainly lock in the need for long-term responsibility. But you may want to balance that against the weight of educational debt that many students end up carrying long after graduation.
One strategy that parents often overlook is to borrow against their own assets. Parents can then make a loan directly to their children to pay for education. As a borrower, the child must still bear the responsibility of paying back the loan, which typically may carry lower interest rates. The family "lender" may choose to have the child refinance the loan upon leaving or finishing school, or, if it is not paid back, the "lender" may choose to deduct it from an inheritance or simply forgive the loan to the child.
529 plan account owners may also withdraw tax-free up to $10,000 to pay student loans, which often account owners plan to do if the student successfully completes their studies.
Plan for the road less traveled
The best-laid plans must account for potential detours. Some children choose to take a gap year for travel, volunteering, or real-world job experience. Others may choose to attend college overseas, or study abroad for a semester.
In many circumstances, you may be able to use 529 plan funds tax-free to pay for those options or some expenses related to them. For example, 529 funds may be used for eligible international schools. Additionally, there’s no time limit on 529 plans. The funds can stay invested and continue compounding while your child explores their passions.
Consider your financial big picture
Always keep your overall financial well-being in mind. For example, avoid underfunding your retirement in favor of education. Seek good financial advice to determine the best funding ratios for you and your family, especially if you have multiple financial goals.
Connect with your Executive Relationship Manager or a Morgan Stanley Financial Advisor to identify an education funding strategy 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.
- 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. Investors should consider many factors before deciding which 529 plan is appropriate. Some of these factors include: the Plan’s investment options and the historical investment performance of these options, the Plan’s flexibility and features, the reputation and expertise of the Plan’s investment manager, Plan contribution limits and the federal and state tax benefits associated with an investment in the Plan. Some states, for example, offer favorable tax treatment and other benefits to their residents only if they invest in the state’s own Qualified Tuition Program. Investors should determine their home state’s tax treatment of 529 plans when considering whether to choose an in-state or out-of-state plan. Investors should consult with their tax or legal advisor before investing in any 529 plan or contact their state tax division for more information. Morgan Stanley Smith Barney LLC does not provide tax and/or legal advice. Investors should review a Program Disclosure Statement, which contains more information on investment options, risk factors, fees and expenses, and possible tax consequences. Assets can accumulate and be withdrawn federal income tax-free only if they are used to pay for qualified education expenses, including tuition, fees, room and board, books and supplies. Earnings on nonqualified distributions will be subject to income tax and a 10% federal income tax penalty tax. State taxes may apply.
- College Board, Trends in College Pricing and Student Aid 2021
How can E*TRADE help?
Save for a child’s education
Tax-free withdrawals for qualified educational expenses, such as tuition and books.