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Learn the Estate Planning Angle for 529 Plans


You've visited your attorney, accountant and estate planner, and they are all in agreement: You should gift assets to your grandchildren as a way to reduce exposure to estate tax. Section 529 college savings programs are relatively newer investment vehicles that allow earnings to grow tax-deferred. Distributions are tax-free when used for qualified postsecondary education costs. As grandparents, you get a dual benefit: advancing your grandchildren's education and reducing estate tax exposure. 

There's no timetable by which you have to spend down 529 funds, and there are no required withdrawals. That's what makes these plans a good vehicle for doing some estate planning while you're saving for college.

These plans don't complicate your overall financial management either. The value of your 529 account is removed from your taxable estate, yet you retain full control, including the right to ask for the money back at any time. Thus, it affords a combination of control and estate reduction.

You can gift up to a certain amount each year to another person and not be subject to the gift tax. If you don't use the current year's exclusion opportunity, you lose it. But you still may be understandably reluctant to do this because you don't wish to irrevocably part with your assets.

However, with a 529 plan, when you ask for the money back, it comes back into your taxable estate, and any withdrawal not used for your beneficiary's qualifying higher education expenses is subject to tax and a 10 percent penalty.

This is why many grandparents find 529 plans particularly attractive. Your 529 plan is typically not counted as an asset in the determination of financial need for federal student aid programs. However, any money actually spent on behalf of the student must be added to student income on the aid application.

Grandparents using a 529 plan to save for a grandchild's college education should open the account in their names if they want to maintain control and retain the ability to change the beneficiary to another grandchild. However, if you and your spouse as grandparents prefer that the parents control the account, you can simply make a contribution into the parents' 529 account (assuming that particular 529 plan accepts contributions from a non-owner).

Another easy way to gift a 529 plan contribution into an account for a grandchild is to make the check out in the name of the 529 plan and hand the check to the parent, who can make sure it is contributed on behalf of your grandchild. For gift tax purposes, the grandparent is still the one making the contribution. 

In any year that your 529 contributions for a particular beneficiary exceed the limit, you may make an election on IRS Form 709 to spread the contributions over five years (20 percent per year) for gift tax purposes. This permits front-loading a substantial amount into a 529 plan without generating a taxable gift, assuming no other gifts to that beneficiary are made during the five-calendar-year period. If you make the five-year election and die before the fifth calendar year, the contributions allocated to the years after your death are included in your taxable estate.

This strategy allows wealthier grandparents to get substantial amounts of money out of their estates. You can take advantage of the five-year front-loading for your grandkids, thinking about it in terms of estate planning.

Contributions to 529 plans are made with after-tax money, and earnings that build up in the account are free of federal and state income taxes when funds are withdrawn for qualified education expenses. 

If your grandchild ends up not needing all the money you've set aside, you can usually change the beneficiary on the plan to another grandchild, for example.  Even if you needed to withdraw the funds for some other purpose, you would get most of your money and earnings back, while owing a 10 percent penalty and taxes on the earnings.

Of course, there are a limited number of people who can afford to set aside astronomical sums. But even smaller savers can benefit by putting money into a 529 plan now. You could, for example, use bonus money or cash received from a tax refund to fund a 529 plan now and add holiday money to the account after next January.

As with many estate planning techniques, there are details you should know before setting up or contributing to a 529 plan. Give us a call and we'll be happy to help you.


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Stephen Holladay
Stephen Holladay
Tax Practice Leader | Partner
(843) 665-5900
1411 Second Loop Road
Florence, SC 29505
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