United States: Part 2: Estate Planning With 529 Educational Savings Accounts

While there are many different ways to save money for education, 529 accounts are widely regarded as the best. Not surprisingly, questions about how to manage 529 accounts are an increasingly important estate planning topic. This three-part series offers an overview of 529 accounts from an estate planning perspective, start to finish! In Part 1, you will find answers to what a 529 account is, how and where to open a 529 account and who should own one. In Part 2, you will gain insight into who can contribute to a 529 account, options and considerations in gifting to a 529 account, investing and using one. In Part 3, you will find answers regarding the income tax consequences of distributions and estate tax treatment of a 529 account, the impact of a 529 accounts on a beneficiary's eligibility for financial aid, whether you can change the beneficiary and alternatives to a 529 accounts. Read on to learn all about these accounts, and please contact Elizabeth Bawden or your Withers estate planning attorney with any related questions.

Who may contribute to a 529 account

A parent, grandparent, or any other friend or family member may contribute to a beneficiary's 529 account so long as the plan sponsor permits this. Be aware, however, that some plan sponsors only permit contributions by the owner of the account.

Gifting to a 529 account

There are many ways to gift to a 529 account.

Annual exclusion gifts. Each year, an individual can gift an amount up to the "annual exclusion" to a 529 account for a beneficiary without any gift tax consequence or reporting. The annual exclusion in Section 2503(b) of the Internal Revenue Code is the total amount any individual can gift to any other person annually, free of gift tax. The annual exclusion is adjusted for inflation, so increases periodically, and in 2022, is $16,000. When determining how much to contribute to a 529 account for a beneficiary, an individual must subtract any direct gifts made to that same beneficiary in the year, as all gifts combined must be under the $16,000 limit to qualify.

Front-loading for maximum growth. Section 529 includes a special provision that allows an individual to front-load a 529 account with up to 5 years' worth of annual exclusion gifts. For example, an individual can contribute $80,000 to a Section 529 plan for one beneficiary in 2022, using her annual exclusion gifts for 2022-2026 in advance. This provides an excellent opportunity for additional growth within a 529 account prior to a beneficiary needing the funds for education. This does mean the individual cannot make additional annual exclusion gifts to the beneficiary during the five-year period, and also requires the filing of a Form 709 Gift Tax Return, for the year of the gift even though no tax is due. See discussion below on estate tax treatment of 529 accounts for a discussion of death prior to the end of the 5 year front-load period.

Other gifts. An individual may gift amounts in excess of the annual exclusion to a 529 account. These gifts must be reported on a Form 709 Gift Tax Return for the year of the gift. Transfers to 529 accounts are also subject to the generation-skipping transfer (GST) tax if the beneficiary is two or more generations removed from the contributor. No gift tax or GST tax is due unless the contributor has used their entire exemption amounts from these taxes. 529 accounts are required to limit contributions in excess of what is necessary to provide for the education expenses of the beneficiary. These amounts vary by state and range from $235,000 to $550,000 per beneficiary (the limit in California is $529,000).

Income tax benefits. There is no federal income tax benefit for gifting to a 529 account. However, a number of states offer a state income tax deduction or credit for contribution to a resident beneficiary's 529 account.

Investing a 529 account

The owner determines how the 529 account is invested, within the options allowed by the plan sponsor. As noted above, costs vary by plan. Many plans have age-based investment options that are more aggressive while the beneficiary is young and become increasingly more conservative as the beneficiary reaches college age.

Using a 529 account

Distributions from a 529 account are available for "qualified education expenses":

Post-secondary education. Generally, tuition, fees, books, supplies and equipment required for the enrollment or attendance of a beneficiary attending a college, graduate school, vocational or trade school, so long as the institution participates in the US Department of Education's federal student aid program. As well, certain costs for room and board may be covered (on-campus room and board or off campus housing up to the cost of on-campus room and board).

Pre-college tuition. While post-secondary education is the focus of 529 accounts, effective January 1, 2018, up to $10,000 per tax year per beneficiary is permitted for tuition at elementary or secondary schools. As well, distributions are permitted for payment of up to a lifetime limit of $10,000 toward principal on any qualified education loan of the beneficiary or their sibling.

Distribution procedure. Each plan sponsor has a different procedure that must be used to request a distribution, and some 529 account owners find it difficult to request and receive distributions in a timely manner. In this case, working with an investment advisor (as mentioned above), may make this process smoother. It is best to have distributions from 529 accounts paid directly to the eligible education institution rather than the owner. However, it is permissible for the owner to pay the qualified education expenses directly and then obtain reimbursement from the 529 account as long as the distribution occurs in the same year the expenses are paid.