Can a 529 plan benefit your estate plan?

One of the many pressures of parenthood is ensuring that you’ll have enough funds to put your children through college. And, along the same lines, you also want the peace of mind that your wealth will be preserved for your children and grandchildren after you’re gone.

One option that can cover both dilemmas is a 529 plan. In a nutshell, it’s one of the most flexible tools available for college savings and it can provide significant estate planning benefits.

529 plan in action
529 plans are college savings or prepaid tuition plans sponsored by states, state agencies and certain educational institutions. Let’s focus on the more popular college savings plans, which generally offer the greatest benefits.

These plans allow you to make cash contributions to a tax-advantaged investment account and to withdraw both contributions and earnings free of federal — and, in most cases, state — income taxes for “qualified higher education expenses.” Qualified expenses include tuition, fees, books, supplies, equipment, and a limited amount of room and board.

Contribution limits
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.”

529 plan pluses
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.

Even better, 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 one, you may contribute as much as $140,000 (5 × $28,000) to each plan 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 six. 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 minuses
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.

Huddle with your advisor
Preparing for life’s many challenges on your own isn’t easy. Consult with a dental financial expert from H+P to help you prepare for the costs of higher education and, looking further into the future, plan for the distribution of your wealth using various estate planning strategies, such as a 529 plan.