Morgan Stanley
  • Wealth Management
  • May 25, 2016

The Real Costs of Not Saving for College

College is expensive enough without the extra cost of borrowing funds to pay for it. That’s why a 529 college savings plan may be a smart move.

A college education is one of the most generous gifts a parent can give a child, but the cost can be daunting. The average price of private four-year tuition will reach $198,770 next year, and higher education costs on the whole have been rising faster than inflation for some time.1

John Hesse, director of field sales relationships for Morgan Stanley, says parents rank assisting their kids with college as their second-highest priority after retirement planning, and for those who have a retirement strategy in place, it's priority number one.

It's clear why: Not being prepared means you or your children will likely be saddled with debt upon graduation. This year's graduates will be the most indebted yet, according to Hesse, owing an average of $35,000 by the time they toss their caps in the air.2

That's why it's incumbent on parents who plan to pay for college to begin saving as early as possible. The benefits of doing so can have untold payoffs down the line.

Save Now or Pay Later

When it comes to paying for college, parents have a choice. “You can pay yourself interest or you can pay the bank interest," explains Hesse. “If you invest now you're earning on your assets. If you borrow later you're paying the bank."

For example, a parent who invests $50,000 over 15 years could end up with $75,000, assuming a 5% return after taxes, according to Hesse. Whereas borrowing $75,000 later could cost anywhere from $100,000 to $150,000, with (an assumed 6%) interest, depending on the length of the loan.

Chalk it up to the power of compounding your money. "The money you put away, particularly in your child's first five years, has the potential to grow dramatically over the next 15," says Tom Benedict, a Morgan Stanley Financial Advisor and Financial Planning Specialist.

Benedict recommends parents take advantage of a 529 College Savings Plan, which affords college savers considerable tax advantages. “The number-one benefit of the 529 plan is that all growth on your investment is free from federal taxes if it’s used for college," he says. That includes college-related expenses, too, like books and room and board. The tax benefits are particularly significant, says Benedict, for people with financial means.

Contribution limits are set by each state, but most top $200,000. Further, you may be eligible for additional tax benefits as certain states offer their own plans with added deductions.

Flexibility and Control

The 529 is flexible as tax-advantaged savings vehicles go. “If you use the money for purposes other than education, you are taxed regular income taxes on any gains plus a 10% penalty," notes Benedict. And there are exceptions in the case of death of a beneficiary or disability.

Anyone can open or contribute to a 529 plan, and your beneficiary can be anyone you choose—a child, grandchild, niece or nephew, spouse or even yourself. The plan can also be set up for unborn children or grandchildren. “It's very flexible. You can even set up a plan for a neighbor if you want," says Benedict.

The account holder maintains full control over the account, not the beneficiary, and can change the beneficiary at any time.3 You can also withdraw some or all of the funds at any time for any reason (although taxes and penalties may apply). Contributions are treated as gifts—up to $14,000 per beneficiary; $28,000 for couples filing jointly—so they may lower your tax liability.

Account holders can disperse funds any way they see fit. If the intended beneficiary decides not to go to college, you can choose another beneficiary. And if a grandparent has invested in a 529 for their grandchild and unexpectedly needs those funds for any reason including their own elder health care, the money can be withdrawn subject to taxes and a possible penalty only on the gains in the account. At no point are you required to turn assets over to the designated beneficiary.

Ultimately, though, “it's a great vehicle for almost anyone because it gets people to save," says Benedict. “And it takes some of the emotion out of choosing a college because cost becomes less of an issue—you've been saving all along."

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.

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