With the rising costs of college, families are taking a multigenerational approach to planning for education and other life goals.
It takes a village to raise a child, but in 2017 it may take an extended family to educate one.
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. However, education costs have now skyrocketed to the extent that saving for both of those life goals—retirement and home-buying—has become hampered in some families.
Some parents are cutting back on retirement savings contributions to help fund their children’s education. At the same time, children are entering their 20’s with student loan debt, which in some cases is delaying the purchase of their first home. Even grandparents have modified life goals, choosing to help grandchildren with education expenses now, rather than leaving a larger legacy later.
In short, paying for education has officially become a multigenerational concern. But with a little advance planning, families can make some savvy moves to help prepare for the costs of college.
The Growing Cost of Education
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. It now costs, on average, $45,370 per year for tuition, fees, room and board, for a four-year private college. Assuming a college-cost inflation rate of 3%, today’s 8-year-old child may need $255,090 come college time in 2027.
“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, Executive Director, Morgan Stanley Wealth Management Investment Solutions.
One option, says Dextraze, is for parents to start saving early with a 529 college savings 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 save, or even pay in advance, for college expenses. Earnings in a 529 plan can be tax deferred, and the withdrawals are 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.
Making Education a Family Affair
Motivated by persistent news headlines about the growing costs of education, grandparents, relatives and even family friends have also begun creating 529 accounts in a child’s name. 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 adulthood free from student debt.
“Today it definitely takes a village to send a child to college," says Jennifer Tierney, Vice President, Morgan Stanley Wealth Management Investment Solutions and 529 plans product manager. “It's so important to plan ahead. 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.”
A Flexible Way to Save and Invest for College
The appeal of 529 plans may derive 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. Virtually anyone can be named a beneficiary—a child, grandchild, niece, nephew, spouse, even a friend.1
According to Chris Stack, a managing consultant at Savingforcollege.com, one of the most overlooked benefits is the daily access and liquidity of the 529 account, as opposed to a UTMA (Uniform Transfers to Minors Act) or UGMA (Uniform Gifts to Minors Act) account or other strategy. “With 529s, grandparents or extended family give themselves an option, but not an obligation, to apply their funds to help pay college costs," he says.
Another significant benefit of 529 plans is tax-free compounding. “Earning on an account’s growth, rather than paying taxes on the earnings, provides more funding available in future years when the college costs become a family reality," Stack says. “Having the ability to withdraw the principal and tax-deferred earnings without any federal or state income tax liability is a very significant benefit, especially when compared to alternative strategies such as using a life insurance policy or a taxable account."
Stack recommends that families start preparing for college costs as early as possible. While as soon as the child is born is ideal, he said, some even “begin with an account in their own name years before their first child is born knowing the designated beneficiary can be changed in the future."
Says Dextraze, “At the end of the day, the idea is to harmonize all of your goals, taking whatever tax advantages you can through the various kinds of plans out there, including 401Ks, 529s and others. It’s using all of the available tools. That’s how you reach your goals.”
1 Some plans may have age, residency or other restrictions and may charge a fee for beneficiary changes, and beneficiary changes may result in an immediate tax liability if the new beneficiary is not a member of the old beneficiary’s family. Contribution limits vary by state. Refer to the individual plan for specific guidelines.
An investor should consider the investment objectives, risks, and charges
and expenses associated with 529 plans and municipal fund securities before
investing. More information about municipal fund securities is available in the
issuer's official statement – the 529 Plan Program Disclosure – which is
available from your Financial Advisor. It should be read carefully before
Investments are subject to market risk and may fluctuate in value. Before
investing, investors should consider whether tax or other benefits are only
available for investments in the investor’s home-state 529 college savings
plan. Assets can accumulate and be withdrawn federally tax-free only if they
are used to pay for qualified expenses. Earnings on nonqualified distributions
will be subject to income tax and a 10% federal income tax penalty. Some states
offer favorable tax treatment and other benefits to their residents only if
they invest in the state’s own Qualified Tuition Program. Investors should
consult with their financial and tax advisor before investing in any 529 plan,
or contact their state tax division for more information. Some plans may have
age, residency or other restrictions and may charge a fee for beneficiary
Morgan Stanley Smith Barney LLC (“Morgan Stanley”), its affiliates and
Morgan Stanley Financial Advisors do not provide tax or legal advice. Clients
should consult their personal tax advisor for tax-related matters and their
attorney for legal matters.
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