A 529 plan is a great way to save for education costs and there are other options you may be able to deploy to raise the funds you need.
Education has outgrown school. What do we mean by that? Even a generation ago, most people tended to think of schooling as finite stages of growing up. Yes, there were costs involved, but like the cuts and scrapes of childhood, they would heal and become a distant memory.
Today, we talk about education as a lifelong journey. It starts with school, but it never really ends. The associated costs have also matured and now resemble longer-term budget items, such as housing and healthcare. In short, paying for education has become a major investment—one that often requires years of careful planning. As the costs keep rising, you should approach funding educational expenses, such as tuition, extension programs and advanced professional training, like any other kind of investment that needs a strategy built for your specific needs.
One of the most challenging aspects of crafting such plans is the difficulty in predicting the future educational funding needs for your loved ones, or yourself. The right solution may be a mix of tried-and-true tools with innovative, lesser-known strategies to help plan for the uncertainty.
Below, Morgan Stanley’s Financial Advisors share their strategies for covering today’s spectrum of (sometimes unexpected) educational costs.
Like most long-range investment strategies, it pays to start early. Popular educational savings tools, such as the 529 education savings plan, reward you for thinking ahead by investing a manageable amount of savings on a regular basis and letting it grow, until you’re ready to make tax-free drawdowns to pay for qualified education expenses, including K-through-12 education. Most, but not all, states offer a state income tax benefit. This is a good topic to take up with your tax advisor.
Here’s how impactful time is in the growth of 529 plans: According to Morgan Stanley projections1, if you open the account when your child is born, you’ll need to contribute $575 a month to have a high likelihood of being able to meet college costs by the time your child graduates from high school. But if you wait until he or she is 12, you would need to save $2,700 a month.
Either way, it’s a lot. You may be able to encourage grandparents, friends, and other relatives to contribute to your child’s 529 plan. For 2019, they can generally make annual contributions up to $15,000 a year for a single person and $30,000 for a married couple without triggering the gift tax, assuming they did not make any other gifts to the same person. They can also take advantage of a feature unique to 529 plans that allows them to make five years of contributions at once without triggering the gift tax2. If they don’t make additional gifts to the same person, an individual can contribute $75,000 for 2019 and a married couple filing jointly can contribute $150,000 (these amounts may change in the future due to cost of living adjustments).
This is just one of many ways 529 plans are extremely flexible and can adapt to a family’s changing needs. Also note: Account holders can change beneficiaries and there is no age limit or required minimum distributions.
When a gap looms between the cost of education and the ability to pay, most families reach for student loans by default. But they’re not always the right option. Interest rates on some student loans can exceed 7%; what’s more, for unsubsidized loans, that rate begins accruing the minute the loan is made, even though payments don’t start until after your child graduates. In addition, student loans are generally not dischargeable in bankruptcy proceedings, and your Social Security benefits may even be garnished to collect balances owed.
Many parents understandably want their children to have some “skin in the game”—and student loans certainly lock in the need for long-term responsibility. But you may want to balance that against the weight of educational debt that many students end up carrying long after graduation.
One strategy that parents often overlook is to borrow against their own assets. Parents can then make a loan directly to their children to pay for education. As borrowers, the child must still bear the responsibility of paying back the loan, which typically may carry lower interest rates. The family “lender” may choose to have the child refinance the loan upon leaving or finishing school, or, if it is not paid back, may choose to deduct it from an inheritance or simply forgive the loan to the child.
The best-laid plans must account for potential detours. Some children choose to take a gap year for travel, volunteering, or real-world job experience. Others may choose to attend college overseas, or study abroad for a semester.
In many circumstances you may be able to use 529 plan funds to pay for those options or some expenses related to them. For example, 529 funds may be used for eligible international schools. Additionally, there’s no time limit on 529 plans. The funds can stay invested and continue compounding while they explore their passions.
To cover other potential out-of-pocket expenses, as well as tutoring and test preparation courses, build an educational cost “safety net,” which may include other savings vehicles and an alternative source of credit.
Planning for children with special needs also requires additional considerations and expenses. You may need funds for occupational, speech, or other therapies, in addition to educational expenses. For these non-educational expenses you should consider funding a health savings account (HSA) if you are eligible. These accounts allow you to use pretax dollars to offset medical-related expenses.
You can also set up a special needs trust that benefits the child. Parents and grandparents may also contribute to the trust, but should be mindful of potential tax implications at the time of transfer. Be sure to engage a special-needs attorney, your tax advisor and consult your Financial Advisor in such cases. Another option is to open a custodial account with your child under the Uniform Gift to Minors Act (UGMA), or similar rules. Proceeds can go toward any use that benefits the named beneficiary, offering the ability to fund a wider range of non-educational expenses for children with special needs. Be sure to consult your Financial Advisor to understand the implications of saving for educational expenses through a UGMA, as it may impact financial aid eligibility.
Sometimes, the education you wish to fund is your own. If you’re planning to pursue a degree and have a young child who may not need the assets for some time, it may be a good idea to name yourself the beneficiary of a 529 account and use those funds to pay for your education.
Always keep your overall financial well-being in mind. For example, avoid underfunding your retirement in favor of education. Seek good financial advice to determine the best funding ratios for you and your family, especially if you have multiple financial goals.
Remember, there is no “one size fits all” approach to education funding, but Morgan Stanley Financial Advisors can help you identify a sound education funding strategy based on your individual circumstances.