Through challenging times, don’t lose sight of how important it is to continue to save and invest for the future education expenses of your children and grandchildren. These ideas can help.
It takes a village to raise a child, but with the costs of college it may take an extended family to finance the education of one. It also takes smart planning, which has become a challenge in 2020 as the pandemic, market volatility and economic lockdowns have pushed families to focus on near-term crisis management.
With the costs of higher education trending higher each year, paying for college has become a top-tier life expense, alongside other big-ticket goals like buying a home and planning for retirement. Education costs, often starting with elementary school and continuing through graduate school, have now skyrocketed to the extent that saving for both of those life goals—retirement and home-buying—has become hampered in some families.
This was a challenge even in “normal” times. But as COVID-19 disrupts global health and markets, the foundations of many families’ income streams have become less stable. The pandemic has pushed everyone—governments trying to flatten the curve, investors focused on volatility, families worried about paying bills—to focus on this week, this month or, at best, this year.
Against this backdrop, it’s important to remember that your loved one’s education is their future and staying the course is essential to help meeting their goals. And unlike the purchase of a new home, college is difficult to postpone.
One approach to navigating volatility and uncertainty is focusing on the future and having a plan. Embrace a “do what you can” mantra for continuing to save and invest for your children’s education, and remember, you’re not in this alone.
According to the College Board's latest “Trends in Higher Education" report, the continued increase in average published tuition and fees at colleges and universities is now outpacing the growth in family incomes, financial aid and many consumer goods and services. For 2019-2020, costs averaged $49,870 per year for tuition, fees, room and board, for a four-year private college.1 Assuming a college-cost inflation rate of 5%, one may need $333,450 come college time in 2029 to pay expenses for today’s 8-year-old child.2
“For parents, the number-one goal from a financial planning perspective is still retirement, but close behind is paying for a child’s education,” says Marc Dextraze, managing director, Morgan Stanley Wealth Management Investment Solutions and Co-head of Product Development for Traditional Investment Products.
It takes a village to raise a child, but with the costs of college it may take an extended family to educate one.
One option, says Dextraze, is for parents to start saving early by investing with a 529 plan. “Having a head start on the costs means less sacrifice later on, avoiding the heavy burden of parental loans," he says. For the child, “having all or most of their college funding in place means they have more options, like being able to select the college that best fits their interests and goals, as opposed to the college that offers the most aid. And graduating with less student debt means having the ability to pursue the next chapter of their lives with more financial freedom."
Named after Section 529 of the Internal Revenue Code, a 529 plan is a tax-advantaged savings vehicle which allows you to invest for future education expenses. Earnings in a 529 plan are tax deferred, and the withdrawals are generally exempt from federal and state income taxes if you use the funds for qualified education expenses, which include tuition, fees, room and board and supplies. Many states also offer state income tax deductions or credits for various amounts invested in certain 529 plans.
Paying for education has become a multigenerational concern. Parents are cutting back on contributions to retirement accounts, students are taking on ever-greater student loan debt (which in some cases is delaying the purchase of their first home), and grandparents have increasingly chosen to help with their grandchildren’s education expenses now rather than leaving a larger legacy later.
In short, families were moving to a “we’re all in this together” mindset even before the COVID-19 crisis. And those with access to good advice knew that with a little advance planning, they could make some savvy moves to help prepare for the future costs of education.
Grandparents, relatives and even family friends have been opening 529 accounts. Not only do 529 plans offer potential tax advantages, they allow the family member or friend to give the gift of education and a young adult to graduate potentially free from student debt.
“Today it definitely takes a village to send a child to college," says Jennifer Tierney, executive director, Morgan Stanley Wealth Management Investment Solutions and 529 plans product manager. “It's so important to plan ahead, beyond short-term market fluctuations. For grandparents, aunts and uncles, family friends, it just makes sense to leverage the benefits that 529 plans provide to a child and, from a tax-perspective, to themselves.”
The appeal of 529 plans is derived from their benefits and flexibility.
There are no income restrictions, no required minimum distributions, no limits on the number of accounts the same person or entity can own, generally no maximum age limits for establishing an account, and high contribution limits as high as $500,000 or more. There are no time limits and therefore an account can generally continue to potentially grow tax-free for multiple generations.
Virtually anyone can be named a beneficiary—a child, grandchild, niece, nephew, spouse, even a friend.3
You, as the account owner, may even be able to use $10,000 tax-free from one or more accounts for a beneficiary per year for elementary and high school tuition. Additionally, as a result of the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, you may have the option of making a one-time payment up to $10,000 toward qualified student loans of the 529 plan designated beneficiary.4
From an estate planning perspective, the contributions anyone makes to a 529 plan are generally excluded from your estate and thus not subject to estate taxes. 529 plan contributions are considered a gift to the beneficiary and can qualify for the annual gift-tax exclusion of $15,000 for 2020 ($30,000 for married couples). Those with the opportunity can take advantage of the five-year gifting election to bundle five years’ worth of contributions in one year.5 One may also consider using their Unified Lifetime Gift Limits, currently set at more than $11.5 million, to enable a contributor to max fund an account at once or over time at their own schedule.
Finally, with depressed valuations in the crisis environment and the tax-filing deadline extended into July this year, families have additional time to consider which plan options would be best positioned for the greatest amount of tax-free gains. “An additional consideration to invest now,” says Chris Stack, Esq., managing consultant at SavingforCollege.com, “is that six states allow a taxpayer to earn an income tax deduction for the prior tax year for contributions made up to April 15th of the succeeding year, which in some cases, such as Iowa and South Carolina, has been extended to July 15th during the current virus crisis.”
“At the end of the day,” says Dextraze, “the idea is to harmonize all of your goals, taking whatever tax advantages you can through the various kinds of plans out there, including 401(k)s, 529s and others. It’s using all of the available tools. That’s how you may reach your goals.”
For many people, the investment component may be very important. While in the decade before the pandemic a rising tide lifted all boats, the crisis is creating a dramatic dispersion between economic winners and losers that rewards active management and the ability to lean on experienced Financial Advisors who help you avoid panic, stay on track and keep working toward future goals.
The power of good advice is magnified in education planning. A Financial Advisor can offer valuable expertise to help you invest for future education expenses within the context of your overall wealth strategy, while navigating current market volatility and regulatory conditions. And they can help you and your tax advisor weigh the tax benefits of staying with an in-state plan or shopping around for appropriate alternatives while factoring in investment choices, ongoing fees and manager track records.
Morgan Stanley offers many 529s 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 for more information.
Morgan Stanley is partnering with College Savings Plans Network and Fred Rogers Productions, the company founded by Mister Rogers and the producers of Daniel Tiger’s Neighborhood, on a campaign to increase awareness of 529 plans and limit college debt for future generations.