Give the Gift of College Savings this Holiday

Give the Gift of College Savings this Holiday

This holiday season, you may want to skip the latest electronic gadget and give your children or grandchildren the gift of higher learning—through a 529 college savings plan.

Named after Section 529 of the Internal Revenue Code, a 529 plan is a tax-advantaged way to save, or even pay in advance, for college expenses.

It should come as no surprise that a college education is expensive, with costs steadily rising. The College Board — a nonprofit educational association — reports that for 2017-2018, the average tuition, fees, room and board, books and supplies for a four-year private college is $46,950 per year ($20,770 for a public in-state institution).

By establishing a 529 plan now you’re not only taking advantage of potential end-of-year tax benefits, you’re giving a child a helping hand toward the skyrocketing cost of higher education.  

Investing In Your Greatest Asset

A 529 comes in two varieties: a pre-paid plan and a savings plan. A pre-paid 529 plan allows the account holder to pre-pay all or part of the tuition and fees of an in-state college education. Pre-paid plans may also be converted for use at out-of-state colleges.

This 529 savings plan works similarly to a Roth IRA and offers investment options similar to mutual funds. Its value can rise and fall based on the performance of the investment option chosen.

Earnings in a 529 plan can be tax deferred, with withdrawals being exempt from federal and state income taxes if you use the funds for qualified expenses such as tuition, fees, room and board and supplies. Many states also offer state tax deductions or tax credits on top of that.

Broad Flexibility

Another key benefit of 529 plans is their flexibility. Some investments that are used for education funding require that the assets be given to the beneficiary when they reach a certain age. With a 529 plan, the owner of the account continues to make all of the decisions. For example, if the beneficiary decides not to go to college, you can choose a different beneficiary or use the plan for your own education needs.

529 savings can also be used for any accredited in-state, out-of-state or international educational institution. And while some education investment vehicles have age restrictions, a 529 plan has none, so anyone can benefit from one.

Additionally, you can usually cover full college costs because the contribution limits per beneficiary generally exceed $300,000. However, contribution limits vary by state, so check with your Morgan Stanley Financial Advisor.

Potentially Significant Tax Benefits

For tax-planning purposes, your 529 plan contribution is considered a gift to the beneficiary and qualifies for the annual gift-tax exclusion of $14,000 for 2017, enabling you to make significant contributions without being subject to the gift tax. Further, for 2017, you can frontload your contribution to as high as $70,000 in one year ($140,000 for married couples), and elect to take that frontloaded contribution into account for purposes of the annual gift-tax reduction over a five-year period. For 2018 the annual gift-tax exclusion will rise to $15,000.

Assets, however, can accumulate and be withdrawn federally tax-free only if they are used to pay for qualified expenses – tuition, fees, room and board and supplies. For non-qualified distributions, gains are subject to ordinary income tax and a 10% penalty tax (unless an exception applies).

529 plans not only may help reduce federal tax, they can, depending upon your state of residence, reduce state income tax. Over thirty states, including the District of Columbia, offer residents a full or partial tax deduction or credit for 529 savings plan contributions. A few states even offer a state tax deduction whether you invest in that state's 529 or not.

Morgan Stanley offers many 529 plans from some of the nation’s leading mutual fund companies. You can choose from a range of investment strategies depending on the specific plan, the age of the beneficiary, your financial objectives and risk tolerance. Talk with your Morgan Stanley Financial Advisor (or find one here) for more information.

1 Source: The College Board, 2017.

Investors should carefully read the Program Disclosure statement, which contains more information on investment options, risk factors, fees and expenses, and possible tax consequences before purchasing a 529 plan. You can obtain a copy of the Program Disclosure Statement from the 529 plan sponsor or your Financial Advisor.

Investors should consider many factors before deciding which 529 plan is appropriate.  Some of these factors include:  the fees, conditions, restrictions, and limitations of the specific plan, the plan’s investment options and the historical investment performance, 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.

Assets can accumulate and be withdrawn federally tax-free only if they are used to pay for qualified expenses. Earnings on nonqualified distributions will be subject to income tax and a 10% federal income tax penalty. Contribution limits vary by state. Refer to the individual plan for specific contribution guidelines. Before investing, investors should consider whether tax or other benefits are only available for investments in the investor’s home state 529 college savings plan. If an account owner or the beneficiary resides in or pays income taxes to a state that offers its own 529 college savings or pre-paid 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 rollover 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.

Investors should consult with their tax or legal advisor before investing in any 529 plan or contact their state tax division for more information.  The discussion of frontloading contributions assumes that the gift giver did not make any frontloading contributions for the benefit of the same beneficiary during the immediately preceding four years as that may result in adverse gift tax consequences. The investor must also consider how a frontloading contribution to a 529 plan may reduce or eliminate the investor’s ability to use the annual gift tax exclusion for future gifts to the same beneficiary during the four years after the year in which the frontloading contribution is made. Morgan Stanley Smith Barney does not provide tax and/or legal advice. 

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