529 Plan – A Double-Edged Sword for College Expenses and Estate and Gift Taxes
My daughter turns 17 this week. As you might imagine, college is a frequent topic of conversation at our house. Where should she go to college? Will she be accepted at her top choices? What should she study? And most significant for her parents — how do we pay for it?
We’ve quickly realized that the cost of a college education is staggering. According to U.S. News & World Report, the average annual tuition and fees at ranked colleges in 2020-21 were almost $9,687 for in-state public colleges, $21,184 for out-of-state public colleges, and $35,087 for private colleges. Add room and board to that cost, and a family is looking at paying an average of $20,000 to $50,000 per year for college. Considering these numbers, it makes sense that some clients, particularly grandparents, may want to include paying for college as part of their estate plan.
Many parents and loved ones save for college by contributing to 529 Plans, but you may not have considered a 529 Plan as an estate planning tool. A 529 Plan is a tax-advantaged investment account. In other words, money contributed to a 529 Plan grows tax-free and can be withdrawn tax-free if it is used for qualified education expenses like tuition and fees, computers, books, and some room and board costs. There is a limit to the amount that can be set aside for each beneficiary, and these limits vary by state (ranging from $235,000 in Georgia to $529,000 in California). However, you don’t have to use your own state’s plan, and accounts can be set up for the same beneficiary in more than one state. The aggregate limit on balances doesn’t generally apply across states.
Using a 529 Plan as part of a long-term gifting strategy has a few advantages.
1. You can transfer wealth and reduce your taxable estate.
- Contributions are considered completed gifts from the donor to the beneficiary, even if the donor is the account owner. Often times donors, like parents, are also the account owners so they can manage the funds for the beneficiary.
- When the account owner dies, the account is usually not included in his or her estate.
- An individual can put as much as $15,000 per year per beneficiary in a 529 Plan without paying federal gift taxes or using part of the lifetime gift tax exemption.
- 529 plans have a special gifting feature that allows you to “front load” gifts. You can make a lump-sum contribution of five times the annual gift tax exclusion, $75,000. The gift is treated as if it was given over five years to avoid federal gift tax (so long as you don’t give other gifts to that beneficiary over the five years). If the donor dies before the five years expires, a portion of the gifted amount is included in the donor’s estate.
2. You retain some control of the gift. Usually, when you give a gift, you lose all your rights to the money and have no control over how it is used. When money is contributed to a 529 Plan, the account owner retains control of the money in the account, even when the beneficiary is no longer a minor.
- You decide how the money is invested within the options offered by the plan.
- You decide how the money will be spent, subject to certain restrictions.
- You decide when the money will be withdrawn.
- You can change the beneficiary of the account without tax consequences as long as the new beneficiary is a member of the original beneficiary’s family, which is defined pretty broadly.
- You can withdraw from the account or close the account and take the money back at any time, but earnings will be taxed and subject to an additional 10% federal tax if not used for qualified educational expenses.
- In some states, you can even name a contingent account owner to assume your rights when you die.
3. There is no income limit for owners of 529 Plans.
- Even high-income earners can contribute and take advantage of the tax breaks offered by many states.
Things to consider when choosing a 529 Plan:
- Whether there is a tax benefit for using your own state’s plan
- Contribution limits
- Investment options