Looking for a more meaningful gift this holiday season? Consider these strategies when gifting to your children or grandchildren - the gift of education—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—recently reported that for the 2022-2023 academic year, the average tuition, fees, room and board, books and supplies, transportation 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.
Potential Gift Tax Benefits and Accelerated Contributions
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, one can frontload their contribution 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 account for purposes of the annual gift tax exclusion over a five-year period.4 The five-year gifting election is a feature unique to 529 plans and accelerated contributions increase the time that assets can potentially grow tax-free, boosting the potential account growth.
A key benefit of 529 plans is their flexibility.
To further maximize this opportunity, one can even take advantage of the six-year gift tax averaging. To do this, before year-end 2023, one can gift $17,000 (or $34,000 for married couples) to a 529 account established for a beneficiary, assuming no other gifts have been made to that beneficiary for the tax year. In or after January 2024, one can take advantage of the five-year gifting option to contribute an additional $85,000 or $170,000 ($17,000 per person or $34,000 for married couples) per beneficiary. Thus, such contributions in both years would allow contributions to total $204,000 for the benefit of each beneficiary for which a 529 account has been established. This also assumes no other gifts are made to them for the year of the gift or the following four years, and no five-year gifting was done for them during the four years immediately preceding the year of the gift.
Furthermore, in addition to the annual gift tax exclusion, any part of the Unified Lifetime Gift Tax Exemption, rose in January 2023 to $12.92 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 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 $540,000 per account/beneficiary.
Gifting a Required Minimum Distribution
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 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 have full control and make all of the decisions. For example, if the beneficiary decides not to go to college, such 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 purpose has expanded to include tuition for K-12 schools. Note that qualified withdrawals for eligible K-12 tuition are limited to $10,000 per beneficiary per year. Additionally, 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. Check to see if your state tax laws conform to the federal tax laws treatment of such expanded qualified expenses.
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.5
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.6
Refine Your Financial Plan for the New Year
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.7 If you have questions or need more information about 529 plans available through Morgan Stanley, contact your Financial Advisor or Private Wealth Advisor today.