Searching for ways to lower the federal taxes that your estate or heirs may owe after your death is exhausting. However, reducing tax liability through wise estate planning isn't as difficult as it may appear. Many savvy investors use 529 plans to help reduce tax liability while providing the next generation a way to pay for K-12 and college education expenses.
A 529 plan is a tax-advantaged savings vehicle available to individuals and families regardless of household income. While it primarily pays for qualified education expenses, it can also be an effective estate planning tool.
Read on to discover how a 529 plan can work double duty as you plan for the distribution of your estate.
Your 529 savings plan is treated as a gift for federal tax purposes
Open a 529 savings account and make deposits to give your beneficiary a way to cover educational expenses after you pass away or even while you're still alive. Your contributions can help lower the tax liability of your estate so more cash is available to pass on to beneficiaries upon your death.
In 2021, up to $15,000 ($30,000 per couple) given to a designated beneficiary of a 529 account is tax-free. For example, if you contribute $16,000 in 2021 to your granddaughter's 529 account, only a small amount would be taxable. Since the account is protected under the federal gift tax rules of the Internal Revenue Service (IRS), only $1,000 of the contribution would be taxable.
If you haven't exceeded the official IRS estate and gift tax basic exclusion amounts for the year, you might be able to forgo paying the federal gift tax on the $1,000. In 2021, thresholds are set at $11.7 million for individuals and $23.4 million for couples.
"This is a strategy that's been around for quite a while," said Joe Delano, registered principal at Delano Financial Management/LPL Financial. "The fact is you can make similar gifts to reduce your estate, but the 529 plan comes with the advantage that you still technically own and control the money. The gifting strategy is particularly useful for mitigating the Massachusetts estate tax versus the federal estate tax because the federal tax only kicks in for much larger estates."
He added, "In Massachusetts, if your estate is over $1 million, even by one dollar, your estate gets hit with the tax. That includes any real estate or retirement accounts, so it hits a lot of people. I think this is where this strategy can be particularly helpful."
You can open multiple 529 plan accounts
If you'd like to support the educational expenses of more than one person, the benefits of using a 529 plan offer even greater savings potential. You can give up to the $15,000 maximum per beneficiary without incurring taxes on the contributions.
For example, if you have 10 grandchildren, you could contribute up to $150,000 during the plan year to lower estate taxes. In this scenario, $15,000 would be applied to 10 separate 529 accounts. Plan to contribute annually to each child's account to maximize the tax-saving benefits.
Few people realize that plan beneficiaries can be non-family members. If you open a new 529 plan account for a non-family member, consider how this might affect other aspects of your estate plan.
Your plan can have multiple beneficiaries
Your designated beneficiary may decide they do not want to pursue higher education. Don't fret. This does not mean you lose tax savings or the benefit of owning the account. You can designate a new beneficiary for the account without penalty, as long as they are a member of the family as defined by the IRS. You could even use the money for your own educational expenses since there are no age limits on who can use the funds.
You retain control of the account
While the funds contributed to a 529 savings plan are no longer part of your taxable estate, you still control how the funds are managed. Feel free to modify investment allocations and designate when the funds will be withdrawn from the 529 account. The beneficiary does not have a say in how the account is managed unless the account holder and beneficiary are one and the same.
You can make lump-sum contributions
Accelerate contributions by making five years' worth of annual gifting to a single 529 plan at one time. But don't stop there. Explore the tax savings potential of making this type of lump-sum contribution across multiple 529 accounts.
For instance, total the number of accounts you would like to fund and multiply the maximum annual contribution amount by five to see how much you could immediately slash from your estate taxes.
# of accounts X $15,000 X 5 years =
Multi-year contributions could help finance your beneficiaries' education sooner while providing substantial tax benefits to your estate. Remember that you may not make another gift to these 529 beneficiaries until the sixth year if you want to stay within the tax-free threshold. Total plan contribution limits vary by the plan administrator.
You can create a tax-advantaged family educational endowment
There's no reason for any money contributed to a 529 plan to go to waste. If the beneficiary decides not to attend college or only uses a portion of the amount in the account, the remaining funds can be applied to another beneficiary. This individual does not have to use the funds right away. The account balance could be saved for a future grandchild or a great-grandchild.
However, you will need to make provisions in your estate for transferring ownership if you pass away or are incapacitated. A common option is for the account owner to name their children as successors of their 529 plans. This way, the accounts are treated as generational, educational endowments that have the potential to last for many years.
There's no need to worry about other college savings plans interfering with your ability to save for the beneficiary as the account owner. Other 529 savings plans that parents or other individuals open for the same beneficiary do not affect the accounts you set up.
Estate planning only sounds complicated. Educational 529 plans and other investment products can help make investment and beneficiary decisions easier for families. Speak with a tax planning professional or estate attorney to discover how a 529 plan fits into your specific estate planning goals.†
When you're ready to plan for the future, download our Savvy Guide to Estate Planning. Our free guide takes the fear and worry out of creating an estate plan and tells you what you need to know to get it done. Download your copy here.
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†Securities and advisory services are offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC). Insurance products are offered through LPL or its licensed affiliates. Hanscom Federal Credit Union is not registered as a broker-dealer or investment advisor. Registered representatives of LPL offer products and services using Hanscom Investment Services, and may also be employees of Hanscom Federal Credit Union. These products and services are being offered through LPL or its affiliates, which are separate entities from, and not affiliates of, Hanscom Federal Credit Union. Securities and insurance offered through LPL or its affiliates are:
Not Insured by NCUA or Any Other Government Agency / Not Hanscom Federal Credit Union Guaranteed / Not Hanscom Federal Credit Union Deposits or Obligations / May Lose Value
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