You may want to skip the latest electronic gadget and give your children or grandchildren the gift of learning—through a 529 education 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 education 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).1
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.
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 additional state tax deductions or tax credits.
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.
The definition of qualified education expenses was recently expanded to include tuition for K-12 schools, as a result of the Tax Cuts and Jobs Act of 2017. The new tax law limits qualified 529 withdrawals for eligible K-12 tuition to $10,000 per beneficiary per year. State tax treatment will vary on a state-by-state basis.2
529 savings plans 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.
For tax-planning purposes, your 529 plan contribution is considered a gift to the beneficiary and qualifies for the annual gift-tax exclusion of $15,000 for 2018 ($30,000 for married couples), enabling you to make significant contributions without being subject to the gift tax. Further, you can frontload your contribution to as high as $75,000 in one year ($150,000 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.
The five-year gifting election is a feature unique to 529 plans and increases the time that assets can grow tax-free, boosting the potential magnitude of the gifts.
If you have the means, you can even take advantage of the six-year gift tax averaging. To do this, you can contribute one years’ worth of gifts in December, followed by five years of contributions in January, effectively making six years’ worth of contributions in just two months.
529 plans not only may help reduce federal tax, they can, depending upon your state of residence, reduce state income tax. Many 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.
If you are taking required minimum distributions from a retirement account but don’t need the funds for everyday expenses, consider using those distributions to fund a 529 for grandchildren or other family members.
While your distribution will be subject to tax, once you invest the funds in a 529 plan they can grow tax-free. Also, any withdrawal used for qualified higher education expenses will be tax-free as well. For large distributions from your retirement account you can take advantage of the accelerated gifting feature described above. For non-qualified distributions from your 529 savings plan, gains are subject to ordinary income tax and a 10% penalty tax (unless an exception applies).
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.