Gift and Estate Tax Benefits of a 529 Plan

college quad.jpgMany of our clients are the planning types. They’re not just creating an estate plan with us. They’re also making a financial plan. And one key aspect of that plan is saving for college. One popular choice for this are 529 plans, named after the section of the tax code that established this plan in 1996. 529 Plans provide tax-free growth for qualified educational expenses and allow you to retain significant control over that money. No other annual gift strategy offers that. It’s a great component of both an estate and a financial plan for parents of young children.

If a parent deposits money into a 529 Plan, and names their child as the beneficiary of the plan, the money in the plan grows income tax free and isn’t taxed when it’s withdrawn, provided the money is used for a qualified educational expense — like college tuition, books, and other educational expenses. If one child can’t use all the money in their account, the money can still be withdrawn tax-free for other defined family members for their educational expenses. A parent can even withdraw the money for non-qualified expenses if need be, though those withdrawals will be subject to both income tax and a ten-percent (10%) withdrawal penalty on the earnings.

What makes these plans unique in the gift and estate tax realm is that a deposit into a 529 Plan is considered a completed gift for tax purposes, but you, as the donor, retain control over the money that’s unlike any other completed gift out there. What that means is that you can deposit $13,000 per child per year into a 529 Plan ($26,000 per couple per child) and those gifts will qualify for your gift tax annual exclusion–which means no gift tax is due and none of your lifetime gift tax credit is used at all. So far, this is like any other annual gift, such as an outright gift. But, if you deposit the money into the 529 Plan, you still have the right to use the money for other qualified beneficiaries, and even to withdraw the money for yourself, if you fall on hard times. (If you do withdraw it for yourself, the money comes back into your taxable estate.) It’s a real gift from the tax code: you can ‘give away’ money for tax purposes, but retain significant control over where that money ultimately goes. AND, you get tax-free growth! No other annual gifting strategy allows you to maintain that kind of control over the money once you give it away.

If you inherit money for a parent, or a grandparent, or work for a lucky start-up, you can even put five years worth of annual gifts ($65,000 per donor per child) into a 529 Plan all at once. This is called ‘front-loading’ and although you can’t make another annual gift for the next five years, you get the benefit of the tax-free growth on the entire amount.

Finally, assets in the 529 Plan aren’t counted as the student’s assets for financial aid calculations. That’s good news, because a child’s own assets are counted more heavily in financial aid formulas. Instead, 529 Plans are counted as belonging to the parent in these calculations.

A well-drafted estate plan should say something in the Will about who to make the custodian of a 529 Plan if both parents die–usually it would be the person serving as Trustee or executor for the parents.

To read more about 529 Plans and saving for college, we often recommend Saving for College.com.