A 529 plan is a great way to save for education costs, and there are also 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 health care. 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 predicting the future educational funding needs of 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-12 education. Most states, but not all, 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: for 2019-2020, costs for a four-year private college averaged $53,980 per year for tuition, fees, room and board, books and supplies, transportation, and other expenses. Assuming a college cost inflation rate of 6%, if you open the account when your child is born, you’ll need to contribute approximately $780 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 they are 12, you would need to save $2,340 a month1.
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 2020, 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' worth of contributions at once without triggering the gift tax2. If they don’t make additional gifts to the same person, an individual can contribute up to $75,000 for 2020 and a married couple filing jointly can contribute up to $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.
Morgan Stanley offers a robust platform of investment options, including the Morgan Stanley National Advisory 529 Plan (coming soon), 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. Contact your Morgan Stanley Financial Advisor or Private Wealth Advisor for more information.
A portfolio of zero-coupon municipal bonds can be a smart way to save for college. This type of fixed income security does not pay interest but instead can be bought at a substantial discount to its face value, which it pays in full at maturity, providing a lump sum equal to the initial investment plus imputed interest. A big plus with these bonds: when purchased from a government entity, their interest is often exempt from federal income tax and usually from state and local income tax as well. And if you need a specific amount of funds at a particular date—for example, when paying college tuition—your Financial Advisor can structure your portfolio so that the bonds mature right before payments would be due.
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 a borrower, 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, the “lender” 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 your child explores 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 noneducational 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 and consult your tax advisor and 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 noneducational 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.