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529 Plans As Estate Planning Tools

July 29, 2021

529 Plans are special accounts that one family member can create for the benefit of another family member to fund educational expenses. Once created, the appreciation in the account is not taxable to either the account owner or the beneficiaries, provided any distributions from the account are used for qualified educational expenses. In addition, in many states the account owner receives a tax deduction for annual contributions to the account. For example, in New York, the account owner may deduct up to $10,000 per year on their New York income tax return for contributions to the sanctioned NY 529 Plan. If the special tax rules that govern these accounts are followed correctly, the account owner may reduce his/her taxable estate and avoid any gift tax consequences. Currently, the lifetime exclusion from estate tax is $11.58 million per person ($23.1 million for a married couple), But that exemption is scheduled to revert back to just over $5 million per person on January 1, 2026 and there are proposals in Congress to accelerate that date.

Currently, every taxpayer may gift $15,000 annually ($30,000 for married couples filing jointly) to any recipient without triggering a gift tax or a gift tax return filing requirement. Amounts given in excess of that amount will reduce the lifetime exemption from estate tax until the exemption is exhausted and thereafter will trigger a gift tax. Under the rules that uniquely govern 529 Plans, you can make a lump-sum contribution to a 529 Plan up to five times the annual gift tax exclusion of $15,000. That means you can gift $75,000 per recipient ($150,000 for married couples), as long as you note your five-year gift on your federal tax return and do not make any more gifts to the same recipient during that five-year period. However, you can elect to give another lump sum after those five years are up. In the meantime, the investments made with your contributions may appreciate tax free. Because a gift to a 529 Plan is treated as a completed gift for tax purposes, should you die before the funds are used for educational purposes, the balance in the Plan will not be part of your taxable estate. Many states impose overall limits to the allowed contributions to a 529 Plan. In New York it is $520k but it resets if there are changes in beneficiaries.

Many people worry that gifting large amounts to a 529 means they’ll irrevocably give up control of those assets. However, 529 Plans allow you quite a bit of control if you title the account in your name. At any point, you can get your money back. But that means it becomes part of your taxable estate again and you’ll have to pay income tax on the gain and an additional 10% penalty on the earnings portion of the withdrawal if you don’t use the money for your designated beneficiary’s qualified education expenses.

If your chosen beneficiary receives a scholarship or financial aid, they may not need some or all of the money you’ve saved for them or a chosen beneficiary may not attend college. Here again, the account owner has options. You can change beneficiaries. You can earmark the money for other qualified educational expenses, e.g certain vocational educational expenses or room, board, books and educational related supplies. Ultimately, if the funds are not needed for any named beneficiary, they can be returned to you or given to the beneficiary for non-educational expenses. You or the beneficiary will owe income tax and the penalty on the gain, but the funds will have appreciated tax free in the meanwhile.

Beneficiaries must be alive at the time an account is created for them. But, you can name a successor owner of the account and that successor can name a successor. The account owner can then name future generations as beneficiaries once born and amounts may be transferred among beneficiaries. Thus, your 529 Plan can benefit future generations. However, transfers to subsequent generations from the original beneficiaries are deemed a new gift, subject to the same rules discussed above.

Creating a 529 Plan should be part of a comprehensive estate plan. Consult your personal advisor or call our office for a consultation.

THE ABOVE INFORMATION IS NOT INTENDED TO PROVIDE SPECIFIC LEGAL ADVICE OR RECOMMENDATIONS. To ensure compliance with requirements imposed by the IRS under Circular 230, we inform you that any U.S. federal tax advice contained in this communication (including any attachments), unless otherwise specifically stated, was not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any matters addressed herein.