Looking for a more meaningful gift this holiday season? Consider giving your children or grandchildren the gift of learning—through a 529 plan.
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 the 2019-2020 academic year, the average tuition, fees, room and board, books and supplies, transportation and other expenses for a four-year private college is $55,800 per year ($27,330 for a public in-state institution).1
Named after Section 529 of the Internal Revenue Code, a 529 plan is a tax-advantaged way to invest, or even pay in advance, for education expenses.
There are various advantages of investing for future education expenses in a 529 plan. Earnings in a 529 plan generally grow tax-deferred, and withdrawals are generally exempt from federal and state income taxes if you use the funds for qualified expenses such as tuition, fees, room and board and supplies.2 Many states also offer a state income tax deduction or credit for your contributions.
529 plans offer an opportunity to gift potentially significant amounts from your estate while still retaining control of the assets and withdrawals as the account owner. For tax planning purposes, your 529 plan contribution is considered a completed gift to the beneficiary and generally qualifies for the annual gift tax exclusion of $15,000 for 2021 ($30,000 for married couples), enabling you to make contributions without being subject to the federal gift tax.
Additionally, you can frontload your contribution to as high as $75,000 in one year per beneficiary ($150,000 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.3 The five-year gifting election is a feature unique to 529 plans and increases the time that assets can potentially 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 year’s worth of gifts in December, followed by five years of contributions in January, effectively making six years’ worth of contributions in just two months.
Furthermore, beyond the annual gift tax exclusion, any part of the Unified Lifetime Gift Tax Exemption, currently at $11.58 million per individual, can be used toward funding a 529 plan. With potential tax code changes and uncertainty around what will happen to this exclusion in 2022, now may be a good time to consider contributing funds to a 529 plan, which may have contribution limits as high as $500,000 per 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 generally grow tax-free. Also, any withdrawal used for qualified education expenses will typically 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 non-qualifying distributions of earnings from a 529 plan are subject to ordinary income tax and may be subject to a 10% penalty tax (unless an exception applies).
A key benefit of 529 plans is their flexibility. Some investment vehicles 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. And while some education investment vehicles have age restrictions, a 529 plan has none.
Further, the definition of qualified education expenses for federal income tax purpose has expanded to include tuition for K-12 schools, as a result of the Tax Cuts and Jobs Act of 2017. Note that qualified withdrawals for eligible K-12 tuition are limited to $10,000 per beneficiary per year. Additionally, under the Setting Every Community Up for Retirement Enhancement Act of 2019, qualified education expenses for federal income tax purposes include (a) up to $10,000 used to repay qualified student loans (b) and certain costs for qualifying apprenticeship programs. The state income tax treatment will vary by state. 2
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.4 If you have questions or need more information about 529 plans available through Morgan Stanley, contact your Financial Advisor or Private Wealth Advisor today.