How are some families planning for future education expenses? According to Sallie Mae’s “How America Saves for College” 2023 report, 30% of families used a college savings account like a 529 to pay for college.1 But did you know a 529 plan can be used for more than just paying for college? They’re tax-advantaged investment plans that can help families save for an array of educational costs and provide other significant benefits. For all their features, 529 plans are still often misunderstood and under-utilized. Here's what you may not know:
5 Things You May Not Know About 529s (But Should)
Mar 5, 2024
They're tax friendly, flexible and available to anyone. Yet, 529 education investment plans are still underused. Here are five things that parents, grandparents and anyone hoping to get a leg up on education costs need to know.
Key Takeaways
- While commonly used for college expenses, 529 plans can also be used for K-12 tuition, post-secondary programs and student loan repayments.
- 529 plans can offer significant tax advantages, including tax-free growth and tax-free withdrawals for qualified education expenses.
- Contributions to a 529 plan can be a strategic part of estate planning, as contributions can count towards your annual gift tax exclusion.
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1They Can Offer Considerable Income Tax Benefits to The Account Owner
529 plans offer federal and state tax-free compounding for as long as funds are invested within the plan. A bonus: there's never a required minimum distribution. Withdrawals for qualified educational expenses are federally tax-free and free of most states' income taxes. Further, most states offer various levels of income tax deductions or credits for contributions to one or more 529 plan to further encourage saving and investing. Check with your tax advisor to see what your state may offer.
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2They're More Flexible Than You Think
There are no income or age limitations, meaning any adult can open an account for any person's future educational expenses. Account owners may change the designated beneficiary for any reason, at any time. They can even name themself as a beneficiary.
Some states require a minimum initial investment, sometimes as low as $15, to start a 529 plan. Additionally, the maximum account contribution limits are generous, ranging from $235,000 up to over $500,000 per beneficiary.2 The plans are state-sponsored, but you can participate in mostly any state's plan. However, you should first consider your home state’s plan as it may offer tax or other benefits exclusive to state residents, such as creditor protection, scholarships and matching contributions.
Funds from a 529 plan may be used tax-free for most expenses at traditional undergraduate and graduate schools. They can also be used for many kinds of post-secondary institutions, such as art or cooking institutes, community colleges, trade and vocational schools and eligible international school expenses. You may even be able to use 529 funds for up to $10,000 in elementary and high school tuition annually.3 Additionally, you can now use up to $10,000 to repay qualified student loans and to cover certain costs for qualifying apprenticeship programs. Connect with your tax advisor to learn more about any state tax implications associated with paying these costs from a 529 account.
Further, effective January 1, 2024, 529 account owners may be able to transfer their qualified leftover funds to a Roth IRA—for the designated beneficiary, without any tax or penalty and with no income limits—making 529 plans an even more robust solution for long-term financial planning.4
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3529 Accounts Provide Unique Estate Planning Benefits
One of the great features of a 529 plan is that, as you fund these accounts for future education expenses, you also are reducing the size of your taxable estate. 529 accounts are generally excluded from your taxable estate and not subject to estate taxes. It’s important to note that you still control the assets and can access your money at any time.
This important benefit of 529 plans allows grandparents and other family members to pass on assets to subsequent generations while enjoying certain tax advantages. With no withdrawal requirement, as owner with full control, you can designate who the account should be transferred to upon your passing. Further, you may change such successor owner at any time, without any tax, cost, penalty, or fee, similar to the ability to change the account’s designated beneficiary.
Anyone, including grandparents, can contribute up to $18,000 per year ($36,000 for married couples) to any individual’s 529 account, utilizing the annual gift tax exclusion.5 Additionally, you can bundle five years of gifts in one year for a total of $90,000 contribution ($180,000 for married couples), provided you make the required election on a gift tax return for the year of the contribution.6 The Unified Lifetime Gift Credit is also available to fund your account up to each 529 plan’s maximum account limit set by the state sponsor, often in excess of $500,000. The credit could be reduced at the end of 2025. Connect with your Financial Advisor about planning for the potential change.
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4529 Accounts Have Minimal Impact on Financial Aid
The impact of a 529 account on financial aid is typically minimal. The short explanation: As long as a parent is the account owner, the student’s needs-based financial aid award will decrease by no more than 5.64% of the account value.7 A 529 account opened by a grandparent has no impact on needs-based financial aid awards.
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5Not All 529 Plans Are the Same
Morgan Stanley offers a variety of 529 plans to help you save while taking advantage of all the benefits. The Morgan Stanley National Advisory 529 Plan offers fiduciary oversight of your account within the context of your broader assets, portfolio and life goals.8 Additionally, other plans offered are backed by some of the nation’s leading investment management companies. Work with your Morgan Stanley Financial Advisor to learn more about which 529 plan may work best for you.
Invest for the Future
When it comes to education costs, every dollar counts.
Speak with your Morgan Stanley Financial Advisor or Private Wealth Advisor to help you invest for future education expenses within the context of your overall wealth strategy.
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1 Sallie Mae, How America Pays For College 2023, https://www.salliemae.com/about/leading-research/how-america-pays-for-college/
2 Maximum contribution limit varies by state. Source: Saving for College, Maximum Contributions, https://www.savingforcollege.com/compare_529_plans/maximum-contributions/
3 Assets can accumulate and be withdrawn federal income tax-free only if they are used to pay for qualified expenses. Qualified expenses include tuition, fees, room and board, books and supplies at virtually any accredited post-secondary school. Effective January 1, 2018, the definition of qualified education expenses 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 and state tax treatment will vary on a state by state basis. The state tax treatment of K-12 withdrawals is under review by many states. Account owners should consult with a qualified tax advisor prior to making such withdrawals as they may be subject to adverse tax consequences. Earnings on non-qualified distributions will be subject to income tax and a 10% federal income tax penalty. Note, the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 signed into law Friday, December 20, 2019, expands the definition of qualified higher education expenses for federal income tax purposes 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 deductible of student loan interest. This new provision applies to 529 plan distributions made after December 31, 2018. The state tax treatment of 529 plans (including the state tax treatment of contributions and 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 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.
4 This change to 529 plan assets is effective January 2024.
5 Source: Morgan Stanley Global Investment Committee Special Report: 529 Plans: A Closer Look at a Versatile Solution, May 2021.
6 If the donor were to die before the five-year period is done, a prorated portion of the contribution would be “recaptured” into the estate for estate tax purposes.
7Although the rules may vary slightly by state, generally, a 529 account owned by a parent for a dependent student is reported on the federal financial-aid application (FAFSA) as a parental asset and is assessed at a (maximum) 5.64% rate in determining the student’s expected family contribution. Source: Saving for College, Does a 529 Plan Affect Financial Aid? By Kathryn Flynn, Dec. 7, 2023 https://www.savingforcollege.com/article/yes-your-529-plan-will-affect-financial-aid
8 The Morgan Stanley National Advisory 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.
For more information on the Morgan Stanley National Advisory 529 Plan clients need to see the applicable ADV brochure available at www.morganstanley.com/ADV.
Disclosures
The Morgan Stanley National Advisory 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.
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.
The 529 Plan Program Disclosure contains more information on investment options, risk factors, fees and expenses, and potential tax consequences. Investors can obtain a 529 Plan Program Disclosure from their Financial Advisor and should read it carefully before investing.
If an account owner or the beneficiary resides in or pays income taxes to a state that offers its own 529 college savings or pre-paid tuition plan (an “In-State Plan”), that state may offer state or local tax benefits. These tax benefits may include deductible contributions, deferral of taxes on earnings and/or tax-free withdrawals. In addition, some states waive or discount fees or offer other benefits for state residents or taxpayers who participate in the In-State Plan. An account owner may be denied any or all state or local tax benefits or expense reductions by investing in another state’s plan (an “Out-of-State Plan”). In addition, an account owner’s state or locality may seek to recover the value of tax benefits (by assessing income or penalty taxes) should an account owner rollover or transfer assets from an In-State Plan to an Out-of-State Plan. While state and local tax consequences and plan expenses are not the only factors to consider when investing in a 529 Plan, they are important to an account owner’s investment return and should be taken into account when selecting a 529 plan.
Investments in a 529 Plan are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so an individual may lose money. Investors should review a Program Disclosure Statement, which contains more information on investment options, risks factors, fees and expenses and possible tax consequences. Investors should read the Program Disclosure Statement carefully before investing.
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