Did You Know 529s Are Powerful Estate Planning Tools

These versatile savings accounts might be the estate planning vehicle you need to learn about.

Most of us associate 529 accounts as college savings vehicles. They’re flexible, allowing you to transfer assets to anyone, including yourself, for the express purpose of furthering the education of your beneficiary. But did you know that a 529 can be a powerful estate planning tool, too?

Modern estate planning

Not everyone is in a position to set aside money for the next generation without jeopardizing their own goals, but if you’re fortunate enough to do so, it’s worth looking into your options.

Specialized savings accounts, informally referred to as 529s, could be at the top of your list. They have quite a few advantages for the beneficiaries – but there are benefits for the donors too, given the high maximum contribution limits and tax advantages.

The special tax rules that govern these accounts allow you to pare down your taxable estate, potentially minimizing future federal gift and estate taxes. Right now, the lifetime exclusion is $13.61 million per person, so most of us don’t have to worry about our estates exceeding that limit.

The framework

Under the rules that uniquely govern 529s, you can make a lump-sum contribution to a 529 plan up to five times the annual limit of $18,000. That means you can gift $90,000 per recipient ($180,000 for married couples) as long as you denote your five-year gift on your federal tax return and do not make any more gifts to the same recipient during that five-year period. However, you can elect to give another lump sum after those five years are up. In the meantime, your investments have the luxury of time to compound and potentially grow.

So, if you’re following along, that $180,000 gift per beneficiary won’t incur gift tax as long as you and your spouse follow the rules. You’ll also whittle your taxable estate by that same amount, potentially reducing future estate tax liabilities. That’s because contributions to 529s are considered a completed gift from the donor to the beneficiary.

Other benefits

Many people worry that gifting large chunks of money to a 529 means they’ll irrevocably give up control of those assets. However, 529s allow you quite a bit of control, especially if you title the account in your name. At any point, you can get your money back. Of course, that means it becomes part of your taxable estate again subject to your nominal federal tax rate, and you’ll have to pay an additional 10% penalty on the earnings portion of the withdrawal if you don’t use the money for your designated beneficiary’s qualified education expenses. 

• If your chosen beneficiary receives a scholarship or financial aid, they may not need some or all of the money you’ve stashed away in a 529. So you’ve got options here, too.
• You can earmark the money for other types of education, like graduate school.
• You can change the beneficiary to another member of the family (ideally in the same generation), as many times as you like, since most 529s have no time limits. This option is particularly helpful if your original beneficiary chooses not to go to college at all.
• You can take the money and pay the taxes on any gains. Normally, you’d expect to pay a penalty on the earnings, too. But that’s not the case for scholarships. The penalty is waived on amounts equal to the scholarship as long as they’re withdrawn the same year the scholarship is received, effectively turning your tax-free 529 into a tax-deferred investment. Of course, you can always use the funds to pay for other qualified education expenses, like room and board, books and supplies, too.
• Starting in 2024, funds in a 529 plan can be rolled into a Roth IRA for the beneficiary if the 529 plan account meets certain requirements. Consult with a tax professional about this option and whether the 529 plan account is qualified for this rollover option.

Plus, many plans offer you several investment choices, including diversified portfolios allocated among stocks, bonds, mutual funds, CDs and money market instruments, as well as age-based portfolios that are more growth-oriented for younger beneficiaries and less aggressive for those nearing college age.

Bottom line

Saving for college takes discipline, as does estate planning. Talk to your professional advisor about the nuances of different investment strategies and vehicles before making a years-long commitment.

Sources: Mercer; Broadridge/Forefield

Earnings in 529 plans are not subject to federal tax and in most cases state tax, as long as you use withdrawals for eligible college expenses, such as tuition and room and board. However, if you withdraw money from a 529 plan and do not use it on an eligible higher education expense, you generally will be subject to income tax and an additional 10% federal tax penalty on earnings. As with other investments, there are generally fees and expenses associated with participation in a 529 plan. There is also a risk that these plans may lose money or not perform well enough to cover college costs as anticipated. Most states offer their own 529 programs, which may provide advantages and benefits exclusively for their residents. An investor should consider, before investing, whether the investor’s or designated beneficiary’s home state offers any state tax or other benefits that are only available for investments in such state’s qualified tuition program. Such benefits include financial aid, scholarship funds, and protection from creditors. The tax implications can vary significantly from state to state.

Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person's situation. You should contact your tax advisor concerning your particular situation. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Investing involves risk and you may incur a profit or loss regardless of strategy selected.