529 Planning

This is the fourth in a series focusing on planning for children. The first article was focused on the importance of planning if you have step-children. The second article focused on the importance of planning if you have “special needs” children. The third article focused on planning for education expenses in general. This fourth article focuses on planning with 529 plans.

A 529 plan, otherwise known as a qualified tuition plan, is a tax-sheltered way of saving for education expenses. These plans are sponsored by states, state agencies, or educational institutions. For a helpful guide to the various 529 plans, click here.

Qualified Tuition Plan Contributions and Distributions

A contribution to a 529 plan is not federally income tax-deductible, though it may qualify for a state income tax deduction in some states. Assets in the plan may be invested in various ways, depending upon the particular plan. Income earned in this type of plan is not taxed currently. In fact, it may never be taxed, depending upon how it is distributed.

Distributions from the 529 plan, if used for the beneficiary’s qualified education expenses, including tuition, books, and other education-related expenses for students at colleges, junior colleges, technical schools, and even at primary and secondary schools (up to $10,000 per year) are income tax-free.

If the distributions aren’t used for qualified education expenses, the earnings would be taxable and may even be subject to a 10% penalty.

Annual Exclusion

Contributions to a 529 plan may qualify for the gift tax annual exclusion (currently $15,000 per year per person). In fact, an individual may utilize up to 5 years of annual exclusions up front. If the donor dies within 5 years, the value of the annual exclusions for the years into which the donor did not survive would be brought back into the donor’s taxable estate. However, any growth on the funds would be out of the donor’s taxable estate.

Typically, if a donor retains control over assets, those assets are included in the donor’s taxable estate. Uniquely, the donor of the 529 plan can keep control of the plan during their life as the owner of the plan and yet the assets in the plan are still removed from the taxable estate. The account owner can change the identity of the beneficiary. So, if you select a successor owner, they could direct the funds away from the beneficiary.

If you want to lock down the 529 plan to make sure your successor doesn’t redirect the funds for themselves or beneficiaries whom they prefer, you could use a trust to hold the plan. However, if you do that, you would be limited to one annual exclusion at a time.

529 Plan Advantages

An added bonus of 529 plans is they may even be exempt in bankruptcy, as long as the funds were contributed at least two years before the donor’s bankruptcy filing, the plan is established for the donor’s children, grandchildren, step-children, or step-grandchildren, and contributions don’t exceed the plan’s maximum contribution limit per beneficiary (which can be in excess of $500,000).

Thus, uniquely, a donor can keep complete control over 529 plan contributions, they may be completed gifts for gift and estate tax purposes, and they may be protected in bankruptcy.

For more detailed information on the use of 529 plans in estate planning, see this detailed article on 529 plans.

Stephen C. Hartnett, J.D., LL.M.
Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com