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 of 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 six strategies that may help cover today’s spectrum of expected, and sometimes unexpected, educational costs.
1. Get Time on Your Side
For 2023, single persons can make contributions of up to $17,000 a year into a 529 plan—and married couples can contribute up to $34,000—without triggering the federal gift tax, assuming they did not 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.1 If they don’t make additional gifts to the same person during the same five-year period, an individual can contribute up to $85,000 for 2023 and a married couple filing jointly can contribute up to $170,000 (these amounts may change in the future due to cost of living adjustments), provided they make the required election on a gift tax return for the year of the contribution.
Your Unified Lifetime Gift Credit, currently $12.92 million, may also be available to fund your account up to the account maximum contribution limit, which varies by state.
2. 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—your Financial Advisor can structure your portfolio so that the bonds mature right before payments would be due.
3. 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. In addition, student loans are generally not dischargeable in bankruptcy proceedings, and your Social Security benefits may even be garnished to collect balances owed.
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.
4. 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.
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.
5. Provide for Special Needs
Planning for children with special needs also requires additional considerations and expenses. You may need funds for occupational, speech or other therapies, in addition to educational expenses. For these non-educational expenses, you should 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 may also contribute to such a special needs trust, but should be mindful of potential tax implications at the time of transfer. Be sure to engage a special-needs attorney and consult your tax advisor and Financial Advisor in such cases.
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 any types of expenses associated with the beneficiary, including any non-educational expenses, such as any expenses associated with a child who has special needs. Be sure to consult your Financial Advisor to understand the implications of saving for educational expenses through a UTMA, as it may affect financial aid eligibility.
6. Fund Your Own Educational Needs
Sometimes the education you wish 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.
A New Role for Roth IRAs?
With the passage of the SECURE 2.0 Act, 529 account owners may be able to roll their leftover assets into a Roth IRA—for a designated beneficiary—making 529 plans an even more robust solution for long-term financial planning.2
The SECURE 2.0 Act contains dozens of provisions that aim to strengthen the retirement system, including raising the age at which many individuals must begin taking required minimum distributions (RMDs), higher catch-up contributions and other improved opportunities to save for retirement. Recognizing the importance of 529 plans in planning for the future, the Act also helps 529 plan account owners, regardless of their income, by permitting tax-free and penalty tax-free rollovers of certain unused funds into a Roth IRA.3
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 Morgan Stanley Financial Advisor to identify an education funding strategy that works for your individual circumstances.
Footnotes:
1 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.
For more information, please see the applicable program disclosure document available at www.morganstanley.com/ADV.
2 This change to 529 plan assets is effective January 2024.
3 This material does not address the impact of state and local income taxes. The state and local income tax treatment of a 529 plan may differ from the federal tax treatment. You should consult with and rely on your own independent tax advisor.
Disclosures:
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.
If an account owner or the beneficiary resides in or pays income taxes to a state that offers its own 529 college savings or prepaid tuition plan (an “In-State Plan”), that state may offer state or local tax benefits. These tax benefits may include deductible contributions, deferral of taxes on earnings and/or tax-free withdrawals. In addition, some states waive or discount fees, or offer other benefits for state residents or taxpayers who participate in the In-State Plan. An account owner may be denied any or all state or local tax benefits or expense reductions by investing in another state’s plan (an “Out-of-State Plan”). In addition, an account owner’s state or locality may seek to recover the value of tax benefits (by assessing income or penalty taxes) should an account owner roll over or transfer assets from an In-State Plan to an Out-of-State Plan. While state and local tax consequences and plan expenses are not the only factors to consider when investing in a 529 plan, they are important to an account owner’s investment return and should be taken into account when selecting a 529 plan.
Tax laws are complex and are subject to change. This information is based upon current tax rules in effect at the time this was written. Morgan Stanley Smith Barney LLC and its Financial Advisors do not provide tax or legal advice. Individuals should always check with their tax or legal advisor before engaging in any transaction involving 529 plans, Education Savings Accounts, trust and estate planning, charitable giving, other tax-advantaged investments, and other legal matters.
Investments in a 529 plan are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so an individual may lose money.
The 529 Plan Program Disclosure contains more information on investment options, risk factors, fees and expenses, and potential tax consequences. Investors can obtain a 529 Plan Program Disclosure from their Financial Advisor and should read it carefully before investing.
This material does not provide individually tailored investment advice with respect to asset allocation or any particular investment. This information is not intended to, and should not, form a primary basis for any investment decision that you may make. Morgan Stanley Smith Barney LLC recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a Financial Advisor. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.
The Morgan Stanley National Advisory 529 Plan Description contains more information on investment options, risk factors, fees and expenses, and potential tax consequences, which should be carefully considered before investing. Investors can obtain a 529 Plan Description from their Financial Advisor and should read it carefully before investing.
The North Carolina State Education Assistance Authority (the "Authority") is an instrumentality of the State of North Carolina sponsoring the Morgan Stanley National Advisory 529 Plan, and the 529 Plan is a component of the Parental Savings Trust Fund established by the General Assembly of North Carolina. Neither the Authority, the State of North Carolina nor any other affiliated public entity or any other public entity is guaranteeing the principal or earnings in any account. Contributions or accounts may lose value and nothing stated herein, the 529 Plan Description and Participation Agreement or any other account documentation shall be construed to create any obligation of the Authority, the North Carolina State Treasurer, the State of North Carolina, or any agency or instrumentality of the State of North Carolina to guarantee for the benefit of any parent, other interested party, or designated beneficiary the rate of return or other return for any contribution to the Parental Savings Trust Fund and the 529 Plan.
Morgan Stanley Smith Barney LLC (“Morgan Stanley”) is the manager of the 529 Plan and is responsible for its administration, distribution and investment management. Morgan Stanley does not provide tax and/or legal advice to investors in the 529 Plan. Investors should consult their personal tax advisor for tax-related matters and their attorney for legal matters. For more information, please see the applicable Morgan Stanley ADV brochure at www.ms.com/adv.
The Morgan Stanley National Advisory 529 Plan is a proprietary offering available exclusively to Morgan Stanley advisory account clients. The Plan is not transferable to other intermediaries.
Zero coupon bonds may experience greater price volatility than interest bearing fixed income securities because of their comparatively longer duration. Municipal zero coupon bonds are generally tax-exempt; however, for taxpayers subject to the AMT, the accreted interest on some municipal bonds may be included in the AMT calculation. Municipal bonds are subject to rules regarding the treatment of any market discount if such bonds are purchased in the secondary market below the bond’s original issue or accreted price. Please consult your tax advisor regarding the consequences of owning zero coupon bonds, as well as the applicable rules that apply to such bonds.
Loan applications are typically subject to underwriting standards and independent approval. Rates and terms are subject to change without notice.
Educational materials are not considered a commitment to lend.
Educational materials should not be construed as tax or legal advice. Individuals should consult their personal tax advisor or attorney for matters involving taxation and tax planning and their attorney for matters involving personal trusts and estate planning.
Borrowing against securities may not be appropriate for everyone. You should be aware that there are risks associated with a securities based loan, including possible maintenance calls on short notice, and that market conditions can magnify any potential for loss.
Morgan Stanley Smith Barney LLC is a registered Broker/Dealer, and not a bank. Where appropriate, Morgan Stanley Smith Barney LLC has entered into arrangements with banks and other third parties to assist in offering certain banking related products and services.
Investment, insurance and annuity products offered through Morgan Stanley Smith Barney LLC are: NOT FDIC INSURED | MAY LOSE VALUE | NOT BANK GUARANTEED | NOT A BANK DEPOSIT | NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY
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