There is a massive industry of financial planners, attorneys and CPAs dedicated to helping clients transfer wealth from one generation to the next in the most tax efficient manner possible. There are hundreds, if not thousands, of complex strategies and trust structures employed to this end. One of the simplest and most efficient is often overlooked, funding the 529 plans of one’s grandchildren.
529 plans are widely known and utilized. This is largely due to their tax advantages and the cost of higher education. 529 plans are considered triple tax advantaged, meaning that contributions may be tax deductible, assets inside the plan grow tax free, and withdrawals are tax free when used for educational purposes. Typically, parents fund an account for their children with contributions based on the maximum annual tax deduction allowed in their state.
One of the main focuses of estate planning is avoiding the federal estate tax. Recently, this has not been a concern for most people as the estate tax exclusion is $13.61 million for individuals or just over $27 million for married couples. This may soon change as the Tax Cuts and Jobs Act is scheduled to sunset in 2025, and the exclusion would revert to approximately $5 million per individual. Under this change, many more estates would exceed the exclusion and be subject to estate taxes. Individuals and couples looking to move money out of their estate can benefit their children and grandchildren (and maybe even great grandchildren) by aggressively funding 529 plans with their grandchildren as beneficiaries. Doing this relieves their children of the heavy burden of paying for higher education and allows these funds to be redirected toward paying down debt, saving for their own retirement, or taking family vacations. As an added benefit, the donor may be able to deduct part of the gift from their adjusted gross income subject to limitations.
One aspect of 529 plans that is less known is the ability to “super fund” them. Any person is allowed to make an annual gift to any other person of $18,000 without paying gift taxes. When gifting to a 529 account you are allowed to contribute 5 years of gifts ($90,000) in year one without paying gift taxes, and a married couple can contribute $180,000 per beneficiary. Keep in mind that any further gifts to the same individual before year 6 would be subject to gift taxes, or a reduction in your estate tax exclusion. In addition to moving a larger sum out of one’s estate, it gives the funds more time to grow before they are needed for education expenses.
How can we utilize this tool in estate planning? Let’s say you and your spouse have five grandchildren. You could gift $180,000 into a 529 account for each of them, reducing your taxable estate by $900,000. Depending on their age, this may grow into an amount that largely covers the cost of their higher education. One could also consider making an additional gift after the five-year period, moving additional funds out of your estate, subject to the lifetime contribution limit per beneficiary from all sources. These limits vary by state, typically between $235,000 to $575,000.
What happens if you put more into the 529 account of one of your grandchildren than they spend on higher education? The first consideration is that you can establish the account with yourself as the owner (person in control). This creates options if the funds are not fully utilized. One can change the beneficiary to another family member, and currently family members include not just brothers and sisters, but also first cousins. This would give you the ability to name another grandchild as the beneficiary of the account and its remaining funds. Another beneficial aspect of 529 accounts is that they don’t expire, meaning there is no need to close the account once the beneficiary has completed their higher education. The money that’s in the account will continue to grow tax free. If the beneficiary has children of their own, they could be named beneficiary of the account, and your wealth would be supporting the higher education of another generation of your family. Another option was recently added that allows for some funds to be converted into a Roth IRA subject to limitations.
As you can see, 529 plans offer significant flexibility in moving money out of your estate while still benefiting your family. Some of the ideas discussed can be complicated to implement, and it would be best to work with a financial planner and CPA. As with most matters, the earlier you begin the process, the better the results are likely to be.