The use of 529 college savings accounts in estate planning
The greatest tax advantage of Section 529 college savings accounts is that it is permitted for them to increase earnings without being subject to federal tax, and generally not to state income tax either. When the account beneficiary reaches college age, tax-free withdrawals can be made to finance the beneficiary’s qualified college expenses. Although 529 plans are normally established for children and grandchildren, it is not required that the donor be related to the beneficiary.
There are also estate planning benefits to making large contributions to 529 plans. Since they are treated as completed gifts, contributions to a 529 account decrease your taxable estate. Thus, they qualify for the annual gift tax exclusion, which is $14,000 for 2016. You can also choose to distribute a lump-sum contribution over a period of five years, and therefore, realize immediate advantages for five years’ worth of gift tax exclusions. Use IRS Form 709, which is the federal gift tax return, to make the election.
For instance, an unmarried grandparent can contribute an amount up to $70,000 in 2016 (5 x $14,000) to a 529 plan established for a grandchild. Married grandparents can make joint contributions of up to $140,000 ($70,000 x 2). If you have many grandchildren, you can make such contributions for as many of them as you wish.
If you choose to make the contributions over a period of five years, they will not diminish your $5.34 million federal gift and estate tax exemption. However, if you die during the five-year period, part of the contribution is added back to your estate for reasons concerning the federal estate tax.
In addition, there is some flexibility regarding the use of 529 accounts. When funding the account, consider what will become of the funds in the event your grandchild decides not to attend college. Under the Internal Revenue Code, you can change account beneficiaries without incurring any federal tax consequences. However, the new beneficiary must be a member of the original beneficiary’s family and of the same generation or higher. And if you need to recover funds from the 529 accounts, you are free to do so. But you will be taxed on any withdrawn earnings and incur a 10 percent penalty.