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Are there estate tax benefits for 529 plans?

March 07, 2019

If you are considering establishing a 529 college savings plan to finance a child’s higher education, then you may be wondering how 529 plan contributions affect your estate’s tax liability.  Great news: contributing to a 529 savings plan can reduce your estate’s tax liability while enabling you to retain control over how the money in the 529 plan account is spent.

Contributions to 529 plans are subject to gift-tax limits as defined by the IRS; however, 529 plan account contributions are not treated as simple gifts over which the donor has no control after the gift is granted.  Many donors seeking to fund a child’s college education choose to establish a 529 plan because, as the account custodian, the donor retains control over how and when the account monies are distributed. Account custodians also control, within the confines of the specific 529 plan’s restrictions, how the account monies are invested.  Without relinquishing these important means of control, donors who contribute money to 529 plans can directly reduce the tax liabilities of their estates. A win-win, for sure! Many estate planners routinely recommend establishing 529 plans for children or grandchildren for the explicit purpose of reducing the tax liability of an estate.

Federal tax laws permit individual taxpayers to gift up to $15,000 per year per person without the contribution being subject to gift taxes.  Married couples who file taxes jointly may contribute up to $30,000 per year per beneficiary without incurring additional tax liability. A taxpayer may gift money each year to as many beneficiaries as he or she chooses.  529 plan account contributions are treated just like any other gift for tax purposes but, as noted above, account custodians retain control over how 529 plan account monies are invested and spent.

Donors to 529 plan accounts may choose to accelerate their gifting schedules by contributing up to $75,000 (or up to $150,00, for married couples filing taxes jointly) to a single beneficiary in a single year.  The contribution is then prorated over a five-year period to avoid incurring any gift tax liability. Donors, to avoid taxation, may not gift any additional money to the same beneficiary in the same five-year period.  In addition, if the donor dies before the five years have passed, then a prorated portion of the gift is credited back to the taxable portion of the donor’s estate.

529 plans are not irrevocable; however, if a custodian does choose to revoke a 529 account, then the value of the account is proportionally reattributed to the taxable portions of the donors’ estates.  Custodians of 529 plan accounts, rather than revoking an account, may choose to reassign the account to another beneficiary. Provided that the new beneficiary is a family member, such as a sibling, parent, child, or niece or nephew, of the original beneficiary, then custodians may reassign the account without triggering any tax consequences.

The capacity of 529 plans to reduce estate tax liability, without relinquishing total control over the funds, makes them particularly popular among grandparents.  Multiple donors may contribute to a single 529 plan account; as such, individuals without grandchildren (or other chosen beneficiaries) who wish to reduce their estate tax liabilities are free to contribute to many different friends’ and family members’ 529 plan accounts as they wish.  

Learn more about establishing 529 plans in multiple states, from the experts at Edmit.