Mark Stevens, CFP®

529 Plans and Estate Planning

529 plans and estate planning

The use of 529 plans for estate planning purposes has emerged thanks to special tax rules surrounding lump sum contributions to 529 plans combined with the convergence of two powerful trends — boomer grandparents and soaring college tuition.


529 Plans and Estate Planning

As the cost of a college education continues to climb out of reach for many parents, grandparents are stepping in to help. This trend may accelerate in the coming years as baby boomers start gifting what is expected to be trillions of dollars over the next few decades. (Source: Why the $41 Trillion Wealth Transfer is Still Valid: A Review of Challenges and Questions, Boston College Social Welfare Research Institute).

Many grandparents may use a 529 plan to help save for their grandchildren's college or graduate school education. 529 plans have become to college savings what 401(k) plans are to retirement savings — an indispensable tool for helping amass money for college. That's because 529 plans offer a unique combination of benefits unmatched in the college savings world: availability to people of all income levels, professional money management, high maximum contribution limits, and generous tax advantages. Funds in a 529 plan can also be used to pay K-12 expenses, up to $10,000 per year.

Yet 529 plans are increasingly being used for another purpose — estate planning. That's because the special tax rules that govern 529 plans allow grandparents to save for their grandchild's college education in a way that simultaneously pares down their estate and minimizes potential gift and estate taxes.

Estate planning framework

To fully appreciate how the gift and estate tax laws favor 529 plans, it's helpful to first understand how these laws apply to other assets. For 2018, every individual has a $5,600,000 basic exclusion amount (plus any unused exclusion amount of a deceased spouse) from federal gift and estate tax. This means that if the total amount of your lifetime gifts and the value of your estate is less than $5,600,000 at the time of your death, no federal gift or estate tax will be owed.

In addition to this basic exclusion amount, individuals get an annual exclusion from the federal gift tax, which is currently $15,000. This means you can gift up to $15,000 per recipient per year gift tax free. And, a married couple who elects to "split" gifts can give up to $30,000 per recipient per year gift tax free.

Finally, gifts made to grandchildren (or anyone who is more than one generation below you) have special tax rules. These gifts are subject to both federal gift tax and an additional tax known as the federal generation-skipping transfer tax (GSTT). However, there are exceptions for this tax too: a lifetime exemption of $5,600,000 in 2018 and an annual exclusion that's the same as for federal gift tax — $15,000 for individuals or $30,000 for married couples.

Special gifting feature of 529 plans

Under special rules unique to 529 plans, you can make a lump-sum contribution to a 529 plan in an amount equal to five times the federal annual gift tax exclusion ($75,000 or $150,000 for a married couple) per recipient, as long as you make a special election on your federal gift tax return that effectively spreads the lump-sum gift evenly over five years, and provided you do not make any other gifts to the same recipient during the five-year period.

Example:  Mr. and Mrs. Brady make a lump-sum contribution of $150,000 to their grandchild's 529 plan in Year 1, electing to spread the gift over five years. The result is they are considered to have made annual gifts of $30,000 ($15,000 per grandparent) in Years 1 through 5 ($150,000/5 years). Because the amount gifted by each grandparent is within the annual gift tax exclusion, the Bradys won't owe any gift tax (assuming they don't make any other gifts to their grandchild during the five-year period). In Year 6, they can make another lump-sum contribution and repeat the process. In Year 11, they can do so again.

Thus, 529 plans offer an opportunity for parents and grandparents to put hundreds of thousands of dollars away gift tax free to help their children and grandchildren with college costs, while paring down their estates and reducing potential estate tax liabilities.

There is a caveat, however. If the donor were to die during the five-year period, then a prorated portion of the contribution would be "recaptured" into the estate for estate tax purposes.

Example:  In the previous example, assume Mr. Brady dies in Year 2. The result is that his total Year 1 and 2 contributions ($30,000) are not included in his estate. But the remaining portion attributed to him in Years 3, 4, and 5 ($45,000) would be included in his estate. However, the contributions attributed to Mrs. Brady ($15,000 per year) would not be recaptured into the estate.

This communication is strictly intended for individuals residing in the state(s) of GA. No offers may be made or accepted from any resident outside the specific states referenced.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2018.