Never Too Affluent for 529 Plans: 529 Gifting and Estate Planning Strategies

High-net-worth individuals are in a unique position when it comes to financing their children’s college education. Not only do they want to provide the best education money can buy, but they also may be seeking ways to reduce their taxable estate while creating an education legacy for future generations. Despite being able to cover the cost of their children’s college education with their current income and assets, these affluent individuals may be pleasantly surprised to learn that no one is too affluent to benefit from a 529 college savings plan. 529 plans are not only effective college savings vehicles, they also have unique gift and estate tax benefits not found anywhere else in the federal tax code. These benefits have great appeal for affluent clients concerned with optimizing their estate planning. This white paper will explore 529 plan strategies for affluent families.

Overview of 529 plans

A 529 plan – named for the section of the Internal Revenue Code that authorizes them – is a tax-favored savings plan that is designed to help families save for college costs. 529 plans may be operated by either a state or higher education institution. States may operate both prepaid or savings plans (most states offer only savings plans), and higher education institutions may offer only prepaid plans (more than 270 institutions offer prepaid plans). A prepaid plan allows a saver to purchase credits calculated, in part, based on today’s tuition costs. A 529 savings plan, on the other hand, allows contributions to accumulate a value that can be used to pay for college education expenses at some time in the future.

529 College Savings Plan Contributions and Limits

529 college savings plans can only accept contributions made in cash. The maximum contribution limit is plan specific, and may vary widely. For example, the maximum contribution per beneficiary for Georgia’s 529 plan is $235,000, whereas the maximum contribution for New York’s 529 plan is $375,000. 529 plan contributions are made on an after-tax basis (that is, tile donor does not receive a federal tax deduction for contributions). Earnings accumulate tax-deferred, and distributions are federal income tax-free if used for qualified higher education expenses of the beneficiary. State tax treatment varies by state; state income tax deductions or credits may be available. Qualified expenditures are tuition, room and board (subject to certain conditions), books, and supplies and equipment required for the course of study at an eligible institution, as well as certain expenses for special needs beneficiaries. An eligible institution is any higher education institution, either U.S. or foreign, eligible to distribute federal financial aid.1 For distributions taken for reasons other than to pay for qualified higher education expenses, the earnings portion of these nonqualified distributions may be subject to income taxation and an additional 10% penalty.

Unique Gift and Estate Tax Characteristics of 529 Plans

Beyond education savings benefits, 529 college savings plans have unique gift and estate tax benefits not found anywhere else in the federal tax code. For 2015, the estate and gift tax exclusion is $5.43 million for individuals ($10.86 million per couple). The generation-skipping transfer (GST) tax exemption is also $5.43 million per individual. For 2015, the tax rate for the estate, gift and GST taxes is 40%.

Benefit #1: A 529 donor’s gift is complete for federal gift tax purposes

Each person has an annual federal gift tax exclusion of $14,000, or $28,000 for a married couple, for 2015. Consequently, a person generally can give up to $14,000 each to any number of people, and none of the gifts will have gift tax consequences. Contributions to a 529 plan qualify for the annual gift tax exclusion. For each donor, a separate annual exclusion applies to each person to whom a gift is given. 529 plans also have a special accelerated gifting rule that allows a donor to gift up to five times the annual gift tax exclusion amount (that is, $70,000 for a single person and $140,000 for a married couple for 2015) in a single year without incurring gift tax consequences. This is known as the five-year accelerated or front-loaded gifting option, which is unique to 529 plans. Maximum accelerated gifting uses the donor’s annual gift tax exclusion for gifts to the beneficiary for the current year and next four years. Any further gifts from the donor to the beneficiary during the five-year period will generally reduce the donor’s unified credit (lifetime exclusion amount), unless the annual exclusion amount increases.

This option enables a donor to make a larger initial gift (thereby allowing for a greater time period of tax-deferred growth), without having to pay gift tax (and without reducing the unified credit, which could be used to offset estate taxes at death). Normally, the total amount of gifts from one individual to another individual in a single year must be equal to or less than the annual gift tax exclusion in order to avoid gift tax consequences. If amounts contributed to a 29 plan exceed the annual gift tax exclusion, an election can be made to treat the contribution as five separate, equal gifts to avoid gift tax consequences, up to a limit of five times the annual gift tax exclusion. So, for example, if a donor wished to contribute $35,000 to a 529 plan for a child or grandchild, it can be treated as five separate, equal gifts of $7,000 over a five year period (for gift tax purposes), as illustrated above. The accelerated gifting option may be particularly attractive to donors who expect to leave a sizeable estate and would like to make a large gift, but do not want to reduce their unified credit (because they would prefer to use it to offset estate taxes). For grandparents, it has the added value of not getting involved with the GST tax.

Accelerated gifting also removes the future growth from estate tax. Donors elect the accelerated gifting option on federal gift tax Form 709. If a donor elects to treat a donation as five separate, equal gifts to avoid gift tax, then the donation will be excludable from his or her estate on a pro rata basis. To fully avoid inclusion in the donor’s estate, the donor must survive to January 1 of the fifth calendar year.

Many high-net-worth individuals use a two-calendar-year giving strategy to maximize gifts, obtain state tax deductions/credits (if available), and avoid gift tax. An example would be if a married couple with two beneficiaries contributed $28,000 to each beneficiary’s plan in one year, and then contributed $140,000 to each beneficiary’s plan the next year. In this case, the married couple contributes a total of $168,000 per beneficiary ($336,000 in total) in two calendar years, but never exceeds the annual gift tax exclusion by electing to treat the second gift as pro rata over a five-year period.

Benefit #2: The 529 account owner maintains rights of property

529 plans allow the account owner, not the beneficiary, to retain control of the account assets (some conditions apply). This is a significant advantage that 529 plans have over other gifting and estate planning vehicles. Consequently, the account owner has the freedom to decide – for any reason – to change beneficiaries on the 529 plan (though there may be gift or GST tax consequences) or to recall the assets. If the assets are not used for qualified higher education expenses of the beneficiary, the earnings portion of the nonqualified distribution will be treated as ordinary income for federal and state income tax purposes and in most instances is subject to a 10% penalty tax.

Benefit #3: 529 assets are excluded from the donor’s or owner’s estate

Although the account owner retains control of the assets in a 529 plan, those assets are excluded from the donor’s or owner’s taxable estate (subject to the limited exception explained previously, i.e., if the donor dies during the five-year period associated with the accelerated gifting option).

Benefit #4: 529 plans are flexible

529 plans are flexible because the account owner can:

  •  Roll over money between beneficiaries who are family members, without income tax ramifications
  •  Change beneficiaries within the family (to a qualified family member) and still preserve tax benefits
  •  Change the beneficiary to future heirs and still avoid gift tax consequences by managing the gift process, as outlined later in this text
  •  Name a successor account owner who will assume control of the account upon death of the account owner while avoiding probate (the successor owner can be an individual or may be a trust)

Managing the Gift Process

If the account owner names a new beneficiary who is one or more generations below the former beneficiary, there is a gift tax event, and tile former beneficiary is the donor for gift tax purposes. When gifts are moved down a generation, the accelerated gifting option can be used to avoid gift tax consequences. Another consideration is the GST tax. Gifts during life or bequests from the estate can also be subject to the GST tax if the gifts or bequests are to a person who is more than one generation younger (for example, a grandchild).

Conclusion 

Based on current income and assets alone, some affluent parents may plan on paying higher education costs out of pocket. This may lead them to forego college savings vehicles such as 529 plans. While that may be a sensible short-term strategy, it should not prevent them from considering 529 plans for longer term estate and legacy planning strategies. Getting a head start on funding the next generation’s education through a 529 plan could lead to decades of tax-deferred growth outside of one’s gross taxable estate. Considering all this, it is safe to say that a person is never too affluent to benefit from a 529 plan.

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax and/or legal advice regarding your individual situation from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security.