An unintended consequence of 529 plans, which originated from an Internal Revenue code permitting them in 1996, is tremendous estate-planning capabilities, particularly for grandparents looking to pass money onto grandchildren and lower their taxable income as an estate-planning technique!
An Intro to 529s
It’s typical to consider tax-advantaged savings plans (like 529s) as nothing more than straightforward and effective ways to save and invest tax-free for college or schooling costs, and for a good reason. Legally known as “qualified tuition plans,” these accounts are sponsored by states, agencies or educational institutions and are authorized by Section 529 of the Internal Revenue Code to allow a saver to open an investment account to save for the beneficiaries future ‘qualified higher education expenses,’ like tuition, fees, room and board, etc. and pay up to $10,000 per year per beneficiary. The plans are funded with after-tax dollars, but all money taken out—including investment gains!—is tax-free as long it’s spent on said qualified education expenses.
In addition to standard potential benefits of these plans, 529s can be perceived as flexible estate-planning tools that can have utility significantly beyond education spending. As the White House is likely to seek higher taxes to fund expanding government programs, tools like this could become more valuable. During his campaign, President Biden proposed reductions of the estate tax exclusion from its current level of $11.7 million per person. If the exemption is lowered significantly, it’s likely that millions of American families suddenly could be looking for ways to reduce their estates- that’s where 529s come in.
An Underutilized Estate-Planning Technique
Most tactics aimed to reduce the size of one’s estate are simply irrevocable. By contrast, both beneficiaries and owners on 529 plans can be changed multiple times. This fact could mean a 529 plan has the potential to serve as a tax-free ‘money pot’ to fund the education financial empowerment and higher education of not only your children, but their children, and many generations to come. Some might even call it a ‘loophole’ in regards to the fact that such a designation could result in the movement of money across generations sans taxes, assuming you don’t hit gift tax exclusions, which allow contributions of up to $15,000 per beneficiary per year. However, the law permits each account owner to pay up to five years’ contribution upfront without triggering gift taxes. That means a couple between them can contribute up to $150,000 per beneficiary in one fell swoop – And they can do it for multiple people. According to the College Savings Plans Network, there is no limit on the number of 529s one can have. That said, a couple with $15 million in assets between them could give $1.5 million to various 529 plans for each of their 10 grandchildren, putting the estate below the federal tax exclusion of $11.7 million per person.
You Stay in Control
It’s valuable to note that although the assets contributed to a 529 plan are no longer considered part of your taxable estate, you’ll still exercise control over the money and when it will be withdrawn within the conditions of the plan’s available investment options. Individuals also have the right to change beneficiaries in the event that the original beneficiary decides not to attend college, and doing so generally won’t trigger tax consequences if the new beneficiary is a member of the original beneficiary’s family (ss detailed in Section 529, qualified family members include the beneficiary’s brothers or sisters, mother or father, sons or daughters, and nieces or nephews, among others.)
In the case that there isn’t another permitted beneficiary, you also have the option of closing the account and taking the money back, although earnings will be subject to applicable federal and state income taxes as well as a 10% additional federal tax unless a specified exception applies. 
A Money Pot to Span Across Generations for Your Family
Suppose you fund a plan for your child and they end up not using all of the money for college. In the period after they graduate and are in a low tax bracket, they could withdraw money and pay taxes on the gains plus the 10% penalty. Considering that the money may have grown tax-deferred in the 529 for a couple of decades, that can still be a good deal. It’s common for individuals to save significant amounts of money in 529 accounts only to find that their children don’t need the money later on, or only exhaust a portion of it. In cases like this, 529 accounts have the potential to grow and fund the education of families’ future generations. Likewise, an affluent couple may contribute money to a 529 and then suffer a financial crisis. In that particular year, they may be in a low tax bracket and can take money out of the 529 without paying much in taxes.
- State-sponsored Section 529 college savings plans have the potential to double as high-powered estate planning tools and any assets you contribute [to a 529 plan account] are removed from your taxable estate and pass into the plan free of federal gift taxes, up to an annual limit of $15,000 ($30,000 per couple.)
- You can make five years’ worth of tax-free gifts in one year, but only once every five years. That means you can contribute up to $75,000 at once ($150,000 per couple), helping to finance a beneficiary’s education while simultaneously minimizing potential estate tax obligations.
- Although the assets gifted to a 529 plan are removed from your estate, you retain control over investment, withdrawal, and beneficiary decisions
- 529 plan contributions and investment earnings can be withdrawn federal (and possibly state) income tax-free as long as the money is used for ’qualified higher education expenses.’ If you make withdrawals for non-qualified purposes, you must pay ordinary applicable federal and state income taxes and may be subject to a 10% additional federal tax, unless a specified exception applies.
- It’s wise to consider important differences between plans before selecting a 529 that’s right for you . For example, compare fees, investment options, and lifetime contribution limits, as they can vary widely from state to state.
IMPORTANT DISCLOSURES: This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal.
Securities offered through LPL Financial, member FINRA/SIPC. Investment advice offered through InVestra Financial Services, a registered investment advisor and separate entity from LPL Financial. Insurance products are offered through LPL or its licensed affiliates.
Prior to investing in a 529 plan, investors should consider whether the investor’s or designated beneficiary’s home state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such states’ qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult your tax advisor before investing.