529 Plan Overview and Lump-Sum Contribution Gift Tax Benefits

Rising costs of college and other higher education over the past several years, coupled with inflation and lack of a matching increase in average salary have made college education out of reach for many families. Baby boomer grandparents are now stepping in more than ever with assistance by helping save for their grandchildren’s education.

Since their creation in 1996, 529 plans have been utilized for college savings much like 401(k) plans are to retirement savings. These plans have become a critical tool for helping build up funds for increasingly costly college expenses.

In addition to the assistance offered to beneficiaries under 529 plans for college expenses, these plans offer generous estate tax advantages as well for wealthy parents and grandparents. While offering the ability to save in a tax-deferred plan that will grow with interest, donors can simultaneously pare down their estate and minimize potential gift and estate taxes.

If you give money or property away during your life, you may be subject to federal gift tax (as well as some state gift taxes as well). Federal gift tax generally applies if you give someone more than the annual gift tax exclusion amount, currently $14,000, during the tax year. There are of course exceptions, including gifts to your spouse. That means you can give up to $14,000 per year, to as many individuals as you like, gift tax free. Over the span of your lifetime, you are allowed a gift tax credit from gift tax for cumulative taxable gifts made during your lifetime which would otherwise be subject to tax, presently $5.43 million for 2015. This credit is tied to the federal estate tax exemption of the same amount.

A contribution to a 529 plan is treated under the federal gift tax rules and qualifies for the federal gift tax exclusion. A special rule for gifting to 529 plans has incredible benefits, as you can make a lump-sum contribution to a 529 plan of up to $70,000, or whatever is the equivalent of 5 times the value of the present day annual gift tax exclusion (i.e., 5 x $14,000 = $70,000). A married couple can both use this benefit in the same year for a contribution of $140,000. In doing so, the donor elects to spread the gift evenly over five years for the benefit of the exclusion. Any amount donated in excess of this exclusion allowance during that five years would be taxable under the gift tax rules but may not incur a gift tax if the donor has any of his or her lifetime exemption left to use as a credit against the tax . The election only applies to the first $70,000 (or $140,000 for married donors).

Grandparent gifts to 529 plans also are subject to the generation-skipping transfer tax (GSTT), a tax on transfers made during your life to someone that is more than one generation below you, such as a grandchild or great-grandchild. This GSTT is imposed in addition to federal gift and estate taxes generally, only the portion that causes a federal gift tax will also result in a GSTT. There is a GSTT exemption for lifetime gifts that is tied to the lifetime estate and gift tax exclusions. Any amount in excess of that amount (presently $5.43 million), would be subject to the GSTT as well.

Generally, a big advantage of using/donating to a 529 plan on another’s behalf is to reduce your taxable estate. When the owner of a 529 plan dies, the value of the 529 account will not usually be included in his or her estate. Instead, the value of the account will be included in the estate of the designated beneficiary of the 529 account, unless of course, the beneficiary does not die before he or she has the chance to use the funds in the account for their intended educational purposes, or, uses them for non-education purposes and pays the tax penalty.

However, some of the value of a 529 account may be included in the estate of the account owner if that person made the five-year election and died before the five-year period. In this case, the portion of the contribution allocated to the years after the account owner died would be included in the owner’s federal gross estate.

Some states have an estate tax like the federal estate tax and many states calculate estate taxes differently. Review the rules in the owner’s state to know how the 529 account will be taxed at death.

When the owner dies, the terms of the 529 plan will control who becomes the new owner. Some states permit a contingent account owner, who would assume all rights upon the death of the original owner. In other states, the ownership may pass to the intended beneficiary. The account could be considered part of the probate estate and pass according to a will, or pass through intestacy if no will.

If the beneficiary dies, the rules of the plan will control. Generally, the account owner retains control of the account and may be able to name a new beneficiary or else make a withdrawal from the account, with a taxable event on any earnings made. However, there wouldn’t be a charge for termination of the account in this instance. If a beneficiary dies with a 529 balance, the balance may be included in the beneficiary’s taxable estate.

If you have any questions about a deduction for a 529 plan (or any other tax question) please do not hesitate to contact the Hood Law Group at 816-561-5000 or send us a message through the form below.

*This post was originally published on December 10, 2015