How to Use a 529 College Savings Plan to Save on Estate Taxes
By Joe Messinger, CFP®
December 3, 2015
Recently we had the opportunity to write for our friends at Alerstallings, attorneys specializing in estate planning and elder law, with locations across Ohio including Columbus and Delaware.
Grandma and Grandpa, are you looking to help your grandchildren pay for their college education? Wouldn’t you also like to see an estate planning benefit? You can by incorporating 529 savings plans in your estate planning strategies.
529 college savings plans can be set up in every grandchild’s name. Investments made into these accounts grow tax deferred, and as long as they are used for higher education they will be distributed tax free. The value of money invested in 529s is removed from the taxable estate, and most importantly grandparents retain full control of the money in the plans and can get it back should they need it for unforeseen expenses or they have a change of heart. This is one of the only vehicles that provides immediate estate planning benefits and allows you to maintain control over the funds.
For tax year 2020, you can give up to $15,000 each to any number of persons in a single year without incurring a taxable gift ($30,000 for spouses “splitting” gifts). Many grandparents fear that they cannot get back the money from the recipient if they need it later and delay starting an annual gifting strategy. This fear is eliminated by using the 529 plan. You just need to be aware that if you decide to take the funds back it comes back into your taxable estate and you will be subject to a 10% federal income tax penalty on the investment growth in the 529 plan.
Once people learn of the unique benefits of the 529 plan they often ask what the maximum amount they can contribute to the plan is. Through a process called front-loading, you can deposit up to 5 years worth of gift amounts and spread those contributions over the 5 year time period with a Form 709 on your income tax form.
Here is an example of how this could work for a married couple:
$15,000 per year/per child for an individual = $30,000 per year/per child for a married couple
Front-load for 5 years = $30,000 x 5 = $150,000 per child
If you had 3 grandchildren, you could remove $450,000 from your taxable estate. Be aware if you do not survive the 5 year period, a proportion of your 529 contribution will revert to the amount subject to federal estate tax.
If your contributions to a 529 plan for a grandchild, when combined with all other gifts to that child during the year, exceed the $15,000 annual exclusion, you must file a gift tax return (Form 709) and compute any gift tax and generation-skipping transfer tax. Everyone has a lifetime exemption of $11,580,000 (in 2020) for gifts, estates, and generation-skipping transfers before taxes are owed. That means $23,160,000 for a married couple. It is worth noting that you can also make unlimited payments directly to medical providers or educational institutions on behalf of others for qualified expenses without incurring a taxable gift. (This is not intended to be a full discussion of the lifetime exemption, what the IRS refers to as the Unified Credit. Consult with your professional advisors on how this and other strategies impact your overall estate plan.)
A few final things to keep in mind…the cost of college weighs heavy on parents so be sure to proactively communicate your plan with your children so they know what to expect. I promise they won’t be mad at you! 529 college savings plans are part of the tax code and subject to change based on the whim of the government so be sure to review your plan regularly with your advisory team. Lastly, this strategy is not reserved for grandparents only and could absolutely be utilized by any individual wishing to help fund a college education for someone they care about.
If estate planning is something you are thinking about, be sure to consider 529 plans as an option for transferring money out of the pot subject to estate taxes and moving it into the pot helping your grandchildren or other loved ones complete their education.
Originally published 12/2015
December 11, 2020
November 27, 2020