Assets in 529 plans have grown significantly in recent years due to their college planning potential. But there’s another side to 529 plans that may appeal to you — potential estate planning benefits.¹

First, a Few Basics

To understand how a 529 college savings plan may complement an estate plan, it’s important to start with a basic review of how a 529 plan works. A 529 plan is a college investment program sponsored by a state government and administered by one or more investment companies. The underlying investment options typically are mutual fund portfolios — “age-based” asset allocations that become more conservative as the beneficiary gets closer to attending college or static portfolios with predetermined allocations that remain consistent over time.

Note that the principal value of an “age-based,” or “target date” fund, cannot be guaranteed at any time, including the target date, and may decline at any time. The target date in the fund is the approximate date when an investor plans to start withdrawing money.

Withdrawals are federally tax free (and state tax free in many cases) as long as they are used to finance qualified college expenses. Nonqualified withdrawals are subject to ordinary income taxes and a 10% additional federal tax. Eligibility to contribute to a 529 plan is generally not restricted by age or income.

The Estate Planning Angle

For tax purposes, a contribution to a 529 plan is considered a completed gift from the contributor to the beneficiary named on the account. A contributor, therefore, can potentially reduce the size of his or her taxable estate using a 529 plan. You may contribute up to $14,000 per beneficiary annually — $28,000 per beneficiary if you contribute jointly with a spouse — without triggering the federal gift tax. So, if you have three grandchildren, for example, and you maintain a 529 plan account for each one, you could remove $42,000 a year from your taxable estate, or $84,000 if you make the contributions jointly with a spouse.

If you want to reduce the size of your taxable estate more quickly, the IRS permits you to make five years’ worth of gifts in a single year as long as you do not provide additional gifts to the beneficiaries for the remainder of the five-year period. In other words, you can accelerate your contributions and gift $70,000 per beneficiary as an individual or $140,000 per beneficiary if done jointly with a spouse. Keep in mind, however, that if you use this strategy, a prorated portion of the contribution may be considered part of your estate if you do not outlive the five-year period.

Regardless of whether you contribute annually or on an accelerated basis, a 529 plan may provide considerable flexibility as part of your estate plan. For example, even though the money in the account is considered a gift to the beneficiary, you maintain control over how it is invested. If the beneficiary does not attend college, you can generally name a new beneficiary who is a relative of the original beneficiary, such as a sibling or cousin.

If you’re grappling with estate planning and college financing decisions that impact a growing family, you may benefit by familiarizing yourself with how a 529 plan could play a role in both of these key areas.

Contact Us so we can help you navigate the complexities of 529 and Estate Planning.

Source/Disclaimer:

¹Investing in 529 plan involves risk, including loss of principal. Before you invest in a 529 plan, request the plan’s official statement and read it carefully. The official statement contains more complete information, including investment objectives, charges, expenses, and the risks of investing in a 529 plan, which you should carefully consider before investing. You should also consider whether your home state or your beneficiary’s home state offers any state tax or other benefits that are only available for investments in such state’s 529 plan. Section 529 plans are not guaranteed by any state or federal agency. By investing in a 529 plan outside of the state in which you pay taxes, you may lose the tax benefits offered by that state’s plan. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary.

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State-sponsored prepaid tuition plans, which are available in many states, allow you to pay tomorrow’s tuition bills at today’s tuition rates. In addition, they allow tax-free withdrawals on earnings if the money is used to pay for qualified education expenses. Parents come out ahead if tuition costs rise faster than the average and would do worse if college costs did not rise as fast. Additionally, grandparents and other relatives — who may be unsure as to what they should buy as gifts — can also contribute to the plan. However, returns under such plans may not stack up to returns you may receive in other investments, such as stocks over the long term.

For parents planning for their children’s college education, there are several investment options to consider. One option is state-sponsored prepaid tuition plans. These plans allow parents to pay today’s tuition rates with the assurance that the child will have the money to go to college when the time comes. They also allow participants to defer paying federal income tax on earnings until money is withdrawn for college.

How Plans Work

Essentially these plans allow parents (and relatives) to “buy” tuition for the child at a fixed price. You either pay in full or pay in installments and you are guaranteed that your investment will keep pace with rising college costs. Depending upon the number of years you have until your child first enters college, your cost may vary.

Since the plans work in part as insurance against rising college costs, there is some degree of speculation involved. Parents come out ahead if tuition costs rise faster than the average and would do worse if college costs did not rise as fast. Historically, tuition costs have risen, keeping pace with inflation and sometimes outpacing the inflation rate. The other hidden benefit is that grandparents and other relatives who may be unsure as to what they should buy as gifts can also contribute to the plan.

Questions to Ask

• Is it transferable? To whom? When?
• What is the enrollment period?
• What costs are covered?

• Can out-of-state residents participate?

• What happens if you stop paying?
• What happens if your child goes to a private college?
• What happens if your child goes to an out-of-state college?
• What is the tax effect?

Pros and Cons

Pros:

• Plans allow you to lock in tomorrow’s college costs today.
• Assets held in prepaid tuition plans are attributed to the account owner, not the beneficiary (student), which results in a lower impact on need-based financial aid.
• Some state plans offer additional tax advantages.

Cons:

• Plan returns may not stack up to returns you might receive in other investments, such as stocks.
• Plans may have limited flexibility. If your child chooses to go to an out-of-state or private college, he or she may receive only some of the benefits. If you want to transfer the amount to a sibling, some plans may disallow it. If your child decides not to go to college at all, or you choose to withdraw money for some other expenditure, you may face very strict refund policies.
• Many plans impose a heavy penalty for withdrawing money for any reason other than college tuition.

Although prepaid plans may not fit every situation’s need, they offer benefits to many parents. It may be to your advantage to learn more about these options.

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Many families cite saving for children’s or grandchildren’s education as one of their top financial goals. If you are among this group, you may want to consider a 529 college savings plan or a Uniform Gifts (or Transfers) to Minors Act account (UGMA or UTMA) — or some combination of these — to help you achieve your goals.

Estate Planning Benefits

A 529 college savings plan offer several key advantages. You maintain control of the investment, the money is removed from your taxable estate and there are no annual contribution limits — although contributions in excess of $14,000 a year ($28,000 if a spouse joins in the gift) are generally subject to the federal gift tax. There is one exception: You may contribute five years’ worth of gifts all at once, or $70,000 per beneficiary, providing you do not provide additional gifts to the same beneficiary during the remainder of the five-year period.¹ Distributions for qualified education expenses are tax-free, and you may change the beneficiary to another qualified family member within certain guidelines.²

A 529 plan is designed to finance higher education, such as college or graduate school.

A Matter of Trust

If you are comfortable having the beneficiary control the investment, you may want to consider an UGMA or UTMA account, an irrevocable trust managed for the benefit of a minor. The account legally belongs to the minor, but the trustee controls it until the minor is age 18 or 21, depending on the state where the minor lives. Assets may be used for any purpose — including education — that benefits the minor.

You may want to review trends in college costs, your financial situation and other factors before selecting the most appropriate college planning strategy. Whatever you decide, your family is likely to benefit from one of life’s greatest advantages — the gift of an education.

Source/Disclaimer:

¹If the account owner takes advantage of the five-year gift tax averaging rule and dies within five years of the funding date, the account owner’s estate will receive only part of the deduction. Please consult your tax advisor.
²Withdrawals used for expenses other than qualified education expenses may be subject to a 10% additional tax on earnings, as well as federal and state income taxes.

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