FAMILY
Give the Gift of Education This Holiday Season
Looking for a more meaningful gift this holiday season? Consider these strategies when gifting to your children or grandchildren—the gift of education—through a 529 plan.
It should come as no surprise that a college education is expensive, with costs steadily rising. The College Board—a nonprofit educational association—recently reported that for the 2022-2023 academic year, the average tuition, fees, room and board, books and supplies, transportation and other expenses for a four-year private college is $57,570 per year.1 Assuming a college-cost inflation rate of 6%, a parent may need $425,500 in 2031 to pay college expenses for today’s 9-year-old.2 And that’s for just one child.
Named after Section 529 of the Internal Revenue Code, a 529 plan is a tax-advantaged way to invest for future education expenses.
There are various advantages of investing in a 529 plan as well as planning strategies to be aware of. Earnings in a 529 plan grow tax-deferred, and withdrawals are generally exempt from federal and state income taxes if the funds are used for qualified education expenses including tuition, fees, room and board and supplies.3 Many states also offer a state income tax deduction or credit for contributions to 529 accounts, but may limit the availability of such credit or deduction to only those contributions made to that state’s sponsored 529 plan.
Potential Gift Tax Benefits and Accelerated Contributions
529 plans offer an opportunity to gift potentially significant amounts from your estate while still retaining control of the assets as the account owner. For federal gift and estate tax purposes, your 529 plan contribution is considered a completed gift to the beneficiary and generally qualifies for the 2023 annual gift tax exclusion of $17,000 ($34,000 for married couples), enabling you to make contributions without being subject to the federal gift tax.
Additionally, for 2023, one can frontload their contribution to as high as $85,000 in one year per account/beneficiary ($170,000 for married couples) and elect to take that frontloaded contribution into the account for purposes of the annual gift tax exclusion over a five-year period.4 The five-year gifting election is a feature unique to 529 plans and accelerated contributions increase the time that assets can potentially grow tax-free, boosting the potential account growth.
To further maximize this opportunity, one can even take advantage of the six-year gift tax averaging. To do this, before year-end 2023, one can gift $17,000 (or $34,000 for married couples) to a 529 account established for a beneficiary, assuming no other gifts have been made to that beneficiary for the tax year. In or after January 2024, one can take advantage of the five-year gifting option to contribute an additional $85,000 or $170,000 ($17,000 per person or $34,000 for married couples) per beneficiary. Thus, such contributions in both years would allow contributions to total $204,000 for the benefit of each beneficiary for which a 529 account has been established. This also assumes no other gifts are made to them for the year of the gift or the following four years, and no five-year gifting was done for them during the four years immediately preceding the year of the gift.
Furthermore, in addition to the annual gift tax exclusion, any part of the Unified Lifetime Gift Tax Exemption, which rose in January 2023 to $12.92 million per individual, can be used toward funding a 529 plan. With potential tax code changes and uncertainty around what will happen to this exclusion in future years, now may be a good time to consider contributing funds to a 529 plan. Depending upon the specific plan, contribution limits may be as high as $540,000 per account/beneficiary.
Gifting a Required Minimum Distribution
If you are taking required minimum distributions from a tax-qualified retirement plan or account, but don’t need the funds for everyday expenses, consider using those distributions to fund a 529 plan for grandchildren or other family members.
While your distribution will be subject to tax, once you invest the funds in a 529 plan they can potentially grow tax-free. Also, any withdrawal used for qualified education expenses will generally be tax-free as well. For large distributions from your tax-qualified retirement plan or account, you can take advantage of the accelerated gifting feature described above. Please note that non-qualifying distributions of earnings from a 529 plan are subject to ordinary income tax and may be subject to a 10% penalty tax (unless an exception applies).
A key benefit of 529 plans is their flexibility. Some investment vehicles 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 have full control and make all of the decisions. For example, if the beneficiary decides not to go to college, such owner can choose a different beneficiary or use the plan for their own education needs. And while some education investment vehicles have income and/or age restrictions, a 529 plan has none.
Further, the definition of qualified education expenses for federal income tax purpose has expanded to include tuition for K-12 schools. Note that qualified withdrawals for eligible K-12 tuition are limited to $10,000 per beneficiary per year. Additionally, qualified education expenses for federal income tax purposes include (a) up to $10,000 used to repay qualified student loans and (b) certain costs for qualifying apprenticeship programs. Check to see if your state tax laws conform to the federal tax laws treatment of such expanded qualified expenses.
With the passage of the SECURE 2.0 Act, 529 account owners may be able to roll their leftover assets into a Roth IRA—for a designated beneficiary—making 529 plans an even more robust solution for long-term financial planning.5
The SECURE 2.0 Act contains dozens of provisions that aim to strengthen the retirement system, including raising the age at which many individuals must begin taking required minimum distributions (RMDs), higher catch-up contributions and other improved opportunities to save for retirement. Recognizing the importance of 529 plans in planning for the future, the Act also helps 529 plan account owners, regardless of their income, by permitting tax-free and penalty tax-free rollovers of certain unused funds into a Roth IRA.6
Refine Your Financial Plan for the New Year
Make the arrival of the new year an occasion to revisit your financial plan and ensure your education funding strategy is on track. A 529 plan is a convenient, flexible and tax-advantaged way to invest for future education expenses. Morgan Stanley offers a variety of investment options, including the Morgan Stanley National Advisory 529 Plan—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.7 If you have questions or need more information about 529 plans available through Morgan Stanley, contact your Financial Advisor today.
Disclosure:
1 “Trends in College Pricing and Student Aid 2022”, The College Board.
2 Projected college costs in 2031 include 6% annual tuition inflation rate: https://bigfuture.collegeboard.org/pay-for-college/college-costs/college-costs -calculator.
3 Assets in a 529 plan potentially grow on a tax deferred basis and can generally be withdrawn federal income tax-free only if they are used to pay for qualified education expenses. Qualified expenses include tuition, fees, room and board, books and supplies at virtually any accredited post-secondary school. Effective for distributions made on or after January 1, 2018, the definition of qualified education expenses for federal income tax purposes expanded to include tuition for K-12 schools, as a result of the 2017 Tax Cuts and Jobs Act. The new tax law limits qualified 529 withdrawals for eligible K-12 tuition to $10,000 per beneficiary per year. Effective for distributions made on or after January 1, 2019, the definition of qualified higher education expenses for federal income tax purposes was expanded to include certain costs associated with qualifying apprenticeship programs and up to $10,000 (lifetime limit per individual) in amounts paid towards qualified student loans of the 529 plan designated beneficiary (or such beneficiary’s sibling). Note, however, using 529 plan distributions to repay qualified student loans may impact the deductibility of student loan interest. The state tax treatment of 529 plans (including the state tax treatment of distributions) may be different from the federal tax treatment and may vary based on the particular 529 plan in which you participate and your state of residence. If the applicable state tax law does not conform with the federal tax law, 529 plan distributions used to pay certain expenses, such as K-12 tuition expenses, principal and interest on qualified student loans and/or qualifying apprenticeship costs, may not be considered qualified expenses for state tax purposes and may result in adverse state tax consequences to the account owner or designated beneficiary. Non-qualified distributions of earnings will be subject to ordinary income tax and may be subject to a 10% federal income tax penalty. Many states allow a partial or full state income tax deduction or credit for contributions to a 529 plan but may limit the availability of such credit or deduction to only those contributions made to that state’s sponsored 529 plan.
4 As of 2023, the annual gift tax exclusion is $17,000 for individuals, and double for married couples at $34,000 annually or $170,000 over a five-year period. An election to do so must be made on a gift tax return for the year of the gift. This assumes there are no frontloaded 529 contributions made by the gift giver for the benefit of the same individual during the prior four years. Any frontloaded 529 contributions made for the benefit of the same individual during the four years prior to the year of the frontloaded contribution may result in a taxable gift. Additionally, any gifts to the same individual during the year of the frontloaded 529 contribution or the four years after the frontloaded 529 contribution is made may result in a taxable gift. If the donor dies within five years of making the frontloaded 529 contribution, the estate will generally recapture a portion of the assets for federal estate tax purposes.
5 This change to 529 plan assets is effective January 2024.
6 This material does not address the impact of state and local income taxes. The state and local income tax treatment of a 529 plan may differ from the federal tax treatment. You should consult with and rely on your own independent tax advisor.
7 The North Carolina State Education Assistance Authority (the "Authority") is an instrumentality of the State of North Carolina sponsoring the Morgan Stanley National Advisory 529 Plan, and the 529 Plan is a component of the Parental Savings Trust Fund established by the General Assembly of North Carolina. Neither the Authority, the State of North Carolina nor any other affiliated public entity or any other public entity is guaranteeing the principal or earnings in any account. Contributions or accounts may lose value and nothing stated herein, the 529 Plan Description and Participation Agreement or any other account documentation shall be construed to create any obligation of the Authority, the North Carolina State Treasurer, the State of North Carolina, or any agency or instrumentality of the State of North Carolina to guarantee for the benefit of any parent, other interested party, or designated beneficiary the rate of return or other return for any contribution to the Parental Savings Trust Fund and the 529 Plan.
Morgan Stanley Smith Barney LLC (“Morgan Stanley”) is the manager of the 529 Plan and is responsible for its administration, distribution and investment management. Morgan Stanley does not provide tax and/or legal advice to investors in the 529 Plan. Investors should consult their personal tax advisor for tax-related matters and their attorney for legal matters. For more information please see the applicable Morgan Stanley ADV brochure at www.ms.com/adv.
The Morgan Stanley National Advisory 529 Plan is a proprietary offering available exclusively to Morgan Stanley advisory account clients. The Plan is not transferable to other intermediaries.
IMPORTANT DISCLOSURES
The 529 Plan Description contains more information on investment options, risk factors, fees and expenses, and potential tax consequences, which should be carefully considered before investing. Investors can obtain a 529 Plan Description from their Financial Advisor and should read it carefully before investing.
Investments in the 529 Plan are not FDIC-insured, nor are they deposits or guaranteed by a bank or any other entity, so an individual may lose money through such investments.
Investors should consider many factors before deciding which 529 plan is appropriate. Some of these factors include: the plan’s investment options and the historical investment performance of these options, the plan’s flexibility and features, the reputation and expertise of the plan’s investment manager, plan contribution limits and the federal and state tax benefits associated with an investment in the plan. Some states, for example, offer favorable tax treatment and other benefits to their residents only if they invest in the state’s own qualified tuition program. Investors should determine their home state’s tax treatment of 529 plans when considering whether to choose an in-state or out-of-state plan. Investors should consult with their tax or legal advisor before investing in any 529 plan or contact their state tax division for more information.
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