As college tuition costs continue to climb, giving the gift of education is not only a boost to a child—it's also a savvy tax planning strategy.
This holiday season, you may want to skip the latest electronic gadget and give your children or grandchildren the gift of higher learning—and give yourself a merry tax break in the process.
Named after Section 529 of the Internal Revenue Code, a 529 plan is a tax-advantaged way to save, or even pay in advance, for college expenses.
It should come as no surprise that a college education is expensive, with costs steadily rising. The College Board—a nonprofit educational association—reports that for 2015-2016, the average cost for tuition, fees, room and board, books and supplies for a four-year private college is $42,224 per year ($21,447 for a public in-state institution). Consider this, if your son, niece or godchild has five years to go before college they may need a whopping $232,271 to cover four years at a private four-year institution.1
By establishing a 529 plan now you’re not only taking advantage of an end-of-year tax benefit, you’re giving a child a helping hand toward the skyrocketing cost of higher education.
A 529 comes in two varieties: a pre-paid plan and a savings plan. A pre-paid 529 plan allows the account holder to pre-pay all or part of the tuition and fees of an in-state college education. Pre-paid plans may also be converted for use at out-of-state colleges.
Earnings in a 529 plan can be tax deferred, with withdrawals being exempt from federal and state income taxes if you use the funds for qualified expenses such as tuition, fees, room and board and supplies. Many states also offer state tax deductions or tax credits on top of that.
Another key benefit of 529 plans is their flexibility. Some investments 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 make all of the decisions. For example, if the beneficiary suddenly decides not to go to college, you can choose a different beneficiary or use the plan for your own education needs.
529 savings can also be used for any accredited in-state, out-of-state or international educational institution. And while some education investment vehicles have age restrictions, a 529 plan has none, so anyone can contribute to one.
Additionally, you can usually cover full college costs because the contribution limits per beneficiary generally exceed $200,000. However, contribution limits vary by state, so check with your Morgan Stanley Financial Advisor.
For tax-planning purposes, your 529 plan contribution is considered a gift to the beneficiary and qualifies for the $14,000 annual gift-tax exclusion, enabling you to make significant contributions without being charged the gift tax. Further, you can frontload your contribution to as high as $70,000 in one year ($140,000 for married couples), then distribute the gift-tax reduction over a five year period.
Assets, however, can accumulate and be withdrawn federally tax-free only if they are used to pay for qualified expenses – tuition, fees, room and board and supplies. For non-qualified distributions, gains are subject to ordinary income tax and a 10% penalty.
529 plans not only help reduce federal tax, they can reduce state income tax. Thirty-four states, including the District of Columbia, offer residents a full or partial tax deduction or credit for 529 savings plan contributions. A few states even offer a state tax deduction whether you invest in that state's 529 or not.
Morgan Stanley offers many 529 plans 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 (or find one here) for more information.