Looking for a more meaningful gift this holiday season? Consider giving your children, grandchildren, nieces and nephews the gift of learning—through a 529 plan.
It should come as no surprise that higher education is expensive, with costs steadily rising. The College Board—a nonprofit educational association—recently reported that for the 2022-2023 academic year, the average tuition, fees, room and board, books and supplies, technology equipment, and other expenses for a four-year private college is $57,570 per year.1 Assuming a college-cost inflation rate of 6%, a parent may need $425,500 in 2031 to pay college expenses for today’s 9-year-old.2 And that’s for just one child.
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. New regulations also may allow you to transfer some unused 529 account funds into a Roth IRA for the same-named beneficiary, provided certain conditions are met.
529 plans offer an opportunity 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, you can frontload contributions 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 consideration for purposes of the annual gift tax exclusion over a five-year period.4 Accelerated contributions increase the time that assets can potentially grow tax-free, boosting the potential account growth. This five-year forward-gifting election is a feature unique to 529 plans.
A key benefit of 529 plans is their flexibility.
To further maximize this opportunity, you can even take advantage of the six-year gift tax averaging. To do this, before year-end 2023, you can gift $17,000 (or $34,000 for married couples) to a 529 account established for a beneficiary, assuming you haven’t made any other gifts to that beneficiary for the tax year. In or after January 2024, you can take advantage of the five-year gifting option to contribute. Thus, such contributions in both years would allow contributions by married couples to total more than $200,000 for the benefit of each beneficiary for which a 529 account has been established. This also assumes they haven’t received any other gifts from you (or, if applicable, you and your spouse) during the 6 year period covered by this contribution strategy.
Furthermore, in addition to the annual gift tax exclusion, any part of the Unified Lifetime Gift Tax Exemption, which rose in January 2023 to $12.92 million per individual and $25.84 million for joint filers, can be used toward funding a 529 plan. With potential tax code changes and uncertainty around what will happen to this exclusion in future years, now may be a good time to consider contributing funds to a 529 plan. Depending upon the specific plan, contribution limits may be as high as $550,000 per account/beneficiary.
If you are taking required minimum distributions from a tax-qualified retirement plan or account, but don’t need the funds for everyday expenses, consider using those distributions to fund a 529 plan 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 potentially grow tax-free. Also, any withdrawal used for qualified education expenses will generally be tax-free as well. For large distributions from your tax-qualified retirement plan or account, you can take advantage of the accelerated gifting feature described above. Please note that you must pay ordinary income tax on non-qualifying distributions of earnings from a 529 plan and you may also owe a 10% penalty tax (unless an exception applies).
A key benefit of 529 plans is their flexibility. Some investment vehicles used for education funding require that the beneficiary receive the assets when they reach a certain age. With a 529 plan, the owner of the account continues to have full control and make all the decisions. For example, if the beneficiary decides not to go to college, the owner can choose a different beneficiary or use the plan for their own education needs. And while some education investment vehicles have income and/or age restrictions, a 529 plan has none.
Further, the definition of qualified education expenses for federal income tax purposes has expanded to include tuition for K-12 schools. Note that qualified withdrawals for eligible K-12 tuition are limited to $10,000 annually, per beneficiary. Also, qualified education expenses for federal income tax purposes have expanded to include using up to $10,000 to repay qualified student loans land certain costs for qualifying apprenticeship programs. Check to see if your state tax laws conform to the federal tax law treatment of these additional qualified expenses.
With the passage of the SECURE 2.0 Act, 529 account owners may be able to roll leftover assets into a Roth IRA—for a designated beneficiary—making 529 plans an even more robust solution for long-term financial planning.5 Under new rules, starting in 2024, you may be able to roll over certain unused 529 plan assets into a Roth IRA for the beneficiary of the 529 plan, if the account has been open for at least 15 years and certain other requirements have been met. These funds will roll over tax-free, and you won’t have to pay any tax penalties on the distribution.
Make the arrival of the new year an occasion to revisit your financial plan and ensure your education funding strategy is on track. A 529 plan is a convenient, flexible, and tax-advantaged way to invest for future education expenses. Morgan Stanley offers a variety of investment options, including the Morgan Stanley National Advisory 529 Plan—a first-of-its-kind advisory 529 plan that enables you to benefit from fiduciary oversight of your education funding strategy within the context of your broader portfolio and life goals.6 If you have questions or need more information about 529 plans available through Morgan Stanley, contact your Financial Advisor or Private Wealth Advisor today.