529 Plans and Estate Planning

Note: Last week, we discussed a tale of a young woman who got $90,000 from her grandparents for college and ran out of money going into her senior year. In that article, I made passing reference to a 529 plan, and I wanted to dig further into what 529 plans are and how they can affect your estate planning.

College is expensive.

It’s getting more expensive (it’s a Youtube video, so beware if sound is an issue).

And, for a lot of jobs, it’s tough to get your foot into the HR office door without a bachelors degree. It’s no wonder, then, that saving for college is an important priority for a lot of parents (and grandparents). One method for doing that saving is by using 529 plans to save for college.

What is a 529 plan?

A 529 plan is a plan that offers tax breaks for saving for college. Most 529 plans are run by states, but some are run by educational institutions as well. Some plans involve paying for college in advance, which others are invested–sort of like a 401(k) plan–in the hopes that the funds will grow when it’s time for the student to go to college.

At the federal level, the tax advantages of a 529 plan are roughly like the tax advantages of a Roth IRA: contributions are not deductible, but for the most part, distributions, including the earnings made on investments in the plan, are tax-free. Some states, however, offer deductions for contributions to a 529 plan. For instance, with Missouri’s 529 plan, account owners can deduct their contributions up to $8,000 per year ($16,000 for a married couple filing jointly) at the state level.

Because 529 plans are designed to pay for college expenses, there are penalties involved if funds aren’t used for “qualified education expenses.” Qualified education expenses include:

  • Tuition and fees
  • Books, supplies, and equipment (which doesn’t cover computers unless the institution requires them, for some reason)
  • Room and board, provided the student is attending at least half-time.

If a distribution isn’t used for qualified education expenses, the earnings are generally both taxable and subject to a 10% penalty, which can be expensive. There are also some exceptions to the penalty, such as death or disability of the beneficiary or income included because the beneficiary got a scholarship, veterans’ assistance, or employer educational assistance.

What does this have to do with estate planning?

If you’re trying to reduce the size of your estate for estate tax purposes, using gifts–including gifts to 529 plans–can reduce your estate. For 2015, you can give $14,000 per beneficiary per year ($28,000 for a couple filing jointly) without triggering the gift tax. Additionally, if you’re really in a hurry to reduce the size of your estate, you can gift up to $70,000 ($140,000 for a couple filing jointly) which covers 5 years of the gift tax limit ($14,000 x 5 = $70,000). Of course, you can’t give anything else for 5 years to that beneficiary without triggering the gift tax. Realistically, that may not be all that helpful; if you were to die before the 5 years ends, the gift would be pro-rated and some of it would be returned to your estate.

If you fund a 529 plan–or engage in any sort of gifting plan, really–you want to consider how that affects your preferred division of assets. For instance, if you really want to make sure all of your children receive equal shares of your estate, but one of the kids doesn’t go to college, or the kids need different amounts for college, you may want to make the gift in some other way or adjust your estate plan to account for the difference in the gifts your children received.

529 plans, then, are not the sort of critical issue that wills or trusts are, but if you’re concerned about the estate tax, they can be a tool in reducing your estate. For more information on the rules about 529 plans, IRS Publication 970 (specifically the part on Qualified Tuition Plans) is a good place to start.

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