A 529 plan can benefit your estate plan

by Adler Pollock & Sheehan P.C.
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Adler Pollock & Sheehan P.C.

As summer vacations wind down and thoughts turn back to school activities, you might find yourself reviewing your finances and considering the options for funding your children’s (or grandchildren’s) college educations. You may be familiar with the basics of a 529 plan, but did you realize it can also benefit your estate plan?

529 plan in action

529 plans are tax-advantaged college-funding plans sponsored by states, state agencies and certain educational institutions. Let’s focus on the popular college savings plan, which generally offers greater benefits than the other 529 option, the prepaid tuition plan.

529 college savings plans allow you to make cash contributions to an investment account and to withdraw both contributions and earnings free of federal — and, in most cases, state — income taxes, as long as the withdrawals are used for “qualified higher education expenses.” Qualified expenses include tuition, fees, books, supplies, computer equipment, software, Internet service, and a limited amount of room and board.

Contributions aren’t deductible for federal income tax purposes. However, many states allow residents to claim a deduction or credit for contributions to in-state 529 plans, and some states offer these tax breaks for contributions to any 529 plan. Be aware that plan accounts are treated as the parents’ asset for financial aid purposes — so long as, of course, the student files as a dependent.

The tax code doesn’t impose a specific dollar limit on contributions. Rather, it requires plans to provide “adequate safeguards to prevent contributions on behalf of a designated beneficiary in excess of those necessary to provide for the qualified higher education expenses of the beneficiary.”

Most plans accept contributions until total in-state 529 plan balances for a beneficiary reach a specified limit, currently ranging from $235,000 to around $500,000, depending on the state.

529 plan and your estate plan

529 plans offer several significant — and unique — estate planning benefits. First, even though you can change beneficiaries or get your money back, 529 plan contributions are considered “completed gifts” for federal gift and generation-skipping transfer (GST) tax purposes. As such, they’re eligible for the annual exclusion, which allows you to make gifts of up to $14,000 per year ($28,000 for married couples) to any number of recipients, without triggering gift or GST taxes and without using any of your lifetime exemption amounts.

In addition, 529 plans allow you to “bunch” five years’ worth of annual exclusions into a single year. Suppose you and your spouse open 529 plans for each of your three children. In Year 1, you may contribute as much as $140,000 (5 × $28,000) to each plan gift-tax-free, for a total of $420,000. Once you’ve taken advantage of this option, however, you won’t be able to make additional annual exclusion gifts to your children until Year 6. And if you die during this period, a portion of your contributions will be included in your taxable estate.

For estate tax purposes, all of your contributions, together with all future earnings, are removed from your taxable estate even though you retain control over the funds. Most estate tax saving strategies require you to relinquish control over your assets — for example, by placing them in an irrevocable trust. But a 529 plan shields assets from estate taxes even though you retain the right (subject to certain limitations) to control the timing of distributions, change beneficiaries, move assets from one plan to another or get your money back (subject to taxes and penalties).

529 plan disadvantages

529 plans accept only cash contributions, so you can’t use stock or other assets to fund an account. Also, their administrative fees may be higher than those of other investment vehicles. And, unlike many such vehicles, your investment choices are usually limited to the plan’s pre-established portfolios.

If withdrawals aren’t used for the beneficiary’s qualified education expenses, the earnings portion is subject to federal income taxes (at the recipient’s tax rate) plus a 10% penalty and, in some cases, state income taxes.

Time to bone up on a 529 plan

If you have college-bound children (or grandchildren), there’s no doubt that you should consider a 529 plan. Keep in mind that contribution limits, investment approaches and tax advantages vary from state to state, so be sure to shop around for a plan that best meets your needs.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Adler Pollock & Sheehan P.C. | Attorney Advertising

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