529 Plans as Tax and Estate Planning Tools
529 Plans are primarily associated with college and education savings, but their benefits extend far beyond. It’s not widely known that the uses of 529 plan funds as well as the limits for contributions have been expanded in recent years, making them an even more viable tax and estate planning vehicle.
Under Section 529 of the Internal Revenue Code, qualified tuition programs are exempt from taxation. There are two types of qualified tuition programs, also known as 529 plans, but this article will discuss only tuition programs under which a person may make contributions to an account which is established for the purpose of meeting the qualified education expenses of the designated beneficiary of the account.
529 Plans Are Not Just for College
Most people associate 529 plans with college and higher education. The scope of 529 plans expanded in 2017; however, when non-higher education schooling, apprenticeship programs, and student loan repayments were added to the list of qualified education expenses. Now, up to $10,000 per year can be spent on tuition costs at qualified private, public, or religious K-12 schools. 529 plan funds may also be used for registered apprenticeship programs, and up to $10,000 may be used for student loan repayment over the lifetime of the plan beneficiary. Moreover, as discussed later in this article, starting in 2024 and subject to certain limitations, excess funds in a 529 plan may be used for funding a Roth IRA.
Parties to a 529 Plan
There are three parties involved in a 529 plan: (1) the account owner, (2) the contributor(s), and (3) the beneficiary. Out of the three parties, the beneficiary is the only one that must be a person, while account owners and contributors can be a person or an entity. The account owner designates the beneficiary, makes investment choices and distributions, and retains control of the account. A contributor makes cash gifts to the 529 plan. The beneficiary is the one whose qualified education expenses are paid.
Income Tax Benefits
There are two primary income tax benefits associated with 529 plans:
- Earnings in 529 plans accumulate tax free, which means no federal or California income taxes are due on earnings as long as the money stays in the 529 plan.
- You will not have to pay federal or California income taxes on withdrawals as long as the money is used to pay for qualified education expenses.
Note that similar to a Roth IRA, contributions to a 529 plan are not deductible from federal or California income taxes.
Gift and Estate Tax Benefits
529 plans are often used as an estate planning vehicle because contributions are considered completed gifts to the beneficiary. Usually for a gift to qualify for the gift tax exclusion, it has to be a gift of a present interest. A 529 contribution is not a gift of a present interest because the beneficiary might not use the money for many years, but by statute this plan qualifies for the annual gift tax exclusion. In 2024, up to $18,000 per donor, per beneficiary, qualifies for the annual gift tax exclusion.
With respect to federal estate taxes, 529 plans are not included in the account owner’s estate, but they are included in the beneficiary’s estate because they are considered a completed gift.
Front-Loading 529 Plans
529 plans offer the unique opportunity for a contributor to front-load their gift tax exclusion to a beneficiary. This is done by taking five years’ worth of the annual gift tax exclusion (currently $90,000), contributing it at once to a 529 plan, and having that entire amount qualify gift-tax free for the next five years. The five year period for front-loading a 529 plan is not variable.
Therefore, if you contribute more than the annual exclusion amount, but less than the maximum five year front-loading amount, whatever amount is donated will be divided prorata over the next five years. To illustrate, if a contribution of $50,000 is made to a 529 plan, the contributor will be deemed to have gifted $10,000 per year to the beneficiary for the next five years. It is important to remember that a contributor will not have any annual gift tax exclusion amount available for the beneficiary for the next five years if they fully front-load a 529 plan.
Opening a 529 Plan
Opening a 529 plan is easy and similar to opening a bank account. There are many options available online, and one of the advantages of 529 plans is that just about anyone can open one. Parents, grandparents, friends, and even students themselves – if they are at least 18 years old – can open a 529 plan. You can open an account and name a beneficiary who does not even know about it until you want them to use the funds.
While anyone can open a 529 plan, each plan can only have one beneficiary. A beneficiary can be anyone of any age who has a social security number or a Tax ID. You can change beneficiaries if one child does not use the funds, but you cannot simultaneously name multiple children as beneficiaries of the same 529 plan.
Contribution limits to 529 plans are determined by each state, as 529 plans are state-sponsored. The current contribution limit for a California-sponsored 529 plan is $529,000. Account owners are free to select a 529 plan from any state, just make sure to compare plan benefits and restrictions before selecting a plan. Furthermore, it is important to pay attention to the costs to maintain the account, including any broker fees.
Distributions
Distributions for qualified expenses are made by the account owner and can be made (1) directly to the institution, (2) by check to both the designated beneficiary and the institution, or (3) to the beneficiary in reimbursement after substantiation of expenses or in advance with certification of application and substantiation within 30 days. Distributions not for qualified expenses are subject to income tax and a 10% penalty.
Changes in 2024
Starting January 1, 2024, up to $35,000 of excess 529 funds can be rolled over into the beneficiary’s Roth IRA tax-free. There are, however, limitations on this type of rollover:
- The Roth IRA must be in the name of the beneficiary, not the account owner of the 529 plan (if the two are different).
- There is a maximum lifetime amount of $35,000 that can be transferred from the 529 plan to the Roth IRA.
- The 529 plan must have been open for more than 15 years, and rollover funds cannot include any contributions to the 529 plan and earnings on those contributions made in the previous five years.
- Rollovers are subject to the annual Roth IRA contribution limit. For the 2024 tax year, the contribution limit is $7,000, or $8,000 for individuals age 50 and older. Thus, it would take several years to reach the full $35,000 rollover allowance.
Additional Information
If you are thinking about opening a 529 plan, the following websites will provide you with additional information regarding specific plans, contributions, and distributions:
College Savings Plans Network
T. Rowe Price College Savings Plan
ScholarShare 529
By Amber M. Bridges
Amber’s practice focuses on the areas of estate planning, trust administration, charitable planning, wealth transfer tax planning, probate, guardianships, and conservatorships.
Disclaimer
This Legal Update / Bulletin is for educational purposes only as well as to give you general information and a general understanding of the law, not to provide specific legal advice. This update should not be used as a substitute for competent legal advice from a licensed professional attorney in your state.
