Paying for Education as Part of an Estate Plan: 529 Plans
One of the most important concerns for high-net-worth clients is how to best pay for the costs of higher education (i.e., college or graduate school) for children and grandchildren. There are a number of options available to help with the costs of education, including: 529 plans, payments made directly to a qualified educational institution, Uniform Transfer to Minors (UTMA) accounts and trusts. Also known as "qualified tuition plans," 529 plans are tax-advantaged savings plans sponsored by states, state agencies or educational institutions. There are two types of 529 plans: the prepaid tuition plan and the college savings plan. Although prepaid tuition plans are no longer common, college savings plans remain an important option for those seeking to pay for future education in a tax-advantaged manner.
College Savings Plans
College savings plans are popular, as they offer greater flexibility than direct prepayment to educational institutions or, where still available, prepaid tuition plans. Participants are free to choose among the available state plans and, with few exceptions, neither the contributor nor the student needs to be a resident of the state whose plan is chosen. Further, plans may be moved from state to state by the owner. Below are key features of these plans.
- Educational Institutions. The funds may be withdrawn at a future date and used for qualified higher education expenses at any eligible educational institution, including a private or public institution, either in-state or out-of-state.
- Covered Expenses. College savings plans cover all "qualified higher education expenses," including tuition, mandatory fees, room and board and expenses incurred in connection with enrollment, including books and computers.
- Front-loaded contributions. Individuals may contribute, free of gift tax consequences, up to five years' worth of annual exclusion gifts. For 2008, the amount a donor may give each year free of gift tax consequences is $12,000. A donor who contributes up to $60,000 in 2008 may amortize the contribution over the next five years by filing a gift tax return showing the allocation of his or her annual exclusion with respect to each student for whom the donor has established a 529 plan.
- Contribution Limits. Many college savings plans limit the aggregate amount that may be contributed. For example, current limitations include $235,000 in New York, $250,000 in Maryland and Virginia, $260,000 in the District of Columbia, $305,000 in New Jersey, $341,000 in Florida and $368,600 in Pennsylvania. These limits restrict only the amount that may be transferred to a 529 plan and do not limit the amount of growth through investment earnings.
- Investment. Each state plan is managed by one or more financial institutions. Investment options and the degree of choice as to investments vary widely by state. College savings plans are not guaranteed by the state, so the investments are subject to market risk.
- No Age Limits. Most states have no age limits for their college savings plans, so they may be created for both adults and children. Accordingly, college savings plans may be the best option to fund the graduate school education of an older student.
- No Residency Requirements. College savings plans generally have no residency requirement. Louisiana is one exception. However, nonresidents may only be able to purchase certain plans through financial advisers or brokers.
- Open Enrollment. College savings plans generally are open all year for enrollment but there may be restrictions on the timing of moving a plan to a different state.
The "account owner" is the person entitled (1) to name (and change) the designated beneficiary of an account and (2) to receive distributions from the account if no person is named as the designated beneficiary. An account owner may be an individual, a trust, an estate, a partnership, an association or a corporation. Upon the death or incompetency of an individual account owner, the successor account owner will be determined either by the terms of the plan or, in the case of an individual owner, the account owner's last will and testament.
Designation of Beneficiaries
The account owner may designate either himself or herself or any other individual, including a nonfamily member, as the "designated beneficiary." The designated beneficiary may be changed without adverse tax consequences to the owner if the new designated beneficiary is a member of the family of the designated prior beneficiary. "Member of the family" includes (1) a spouse, (2) a child or more remote descendant, (3) a sibling or step-sibling, (4) a parent or step-parent, (5) a niece or nephew, (6) an aunt or uncle, (7) a first cousin or (8) a son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law. If the new designated beneficiary is one generation below the prior beneficiary, the change will be deemed to be a gift from the prior designated beneficiary to the new designated beneficiary, even though the prior designated beneficiary is not the account owner and does not control the 529 plan. If the new beneficiary is at least two generations below the prior beneficiary, GST tax consequences will result.
A "contributor" is an individual or an entity who makes a contribution or direct allocation to a 529 plan account for the benefit of a designated beneficiary. The contributor does not need to be the account owner. Contributions to 529 plans may only be made in cash or by rolling over another 529 plan or Coverdell Education Savings Account (formerly called "education IRAs"). Contributions are not deductible for federal income tax purposes, but many states allow a state income tax deduction for a portion of the contributions made to a 529 plan sponsored by that state, or in some cases, another state.
Investment of Funds
Funds contributed to a 529 plan grow free of income tax for federal and, in most cases, state income tax purposes. The account owner may either change investment strategies or roll over the account to another 529 plan only once per 12-month period. If the plan is rolled over to a 529 plan sponsored by a different state, the previous state may require a contributor to recapture previous state income tax deductions taken.
Funds may be withdrawn from a 529 plan account by the designated beneficiary without income tax consequences if the funds are used to pay for qualified higher education expenses. However, if money is withdrawn from a 529 plan and is not used for these expenses, the withdrawn amount will be subject to income tax plus a 10 percent federal income tax penalty on earnings.
Gift Tax Consequences
A contribution to a 529 plan is considered a completed gift for gift tax purposes. The contributions are eligible for the annual gift tax and GST tax exclusion. Married donors can make split contributions to 529 plans. Additionally, contributors may "frontload" the contributions by making a contribution of up to five times the annual exclusion amount and taking the contribution into account over a five-year period. However, there are adverse estate tax consequences if the contributor does not survive the five-year period.
Estate Tax Consequences
If the account owner dies before all funds in the 529 plan account are distributed, the value of the account will not be included in his or her gross estate for federal estate tax purposes. However, if a contributor elected to "frontload" the contributions, any amount prorated to the period after death would be included in his or her gross estate. In addition, although it is not entirely clear, the IRS has indicated that the value of any funds remaining in the account will be included in the designated beneficiary's estate upon his or her death.
Disadvantages of 529 Plans
Before investing in a 529 plan, an individual should take the following considerations into account:
- Annual Exclusion Limitations. If there is a competing use for the annual gift tax exclusion with respect to the beneficiary, a contribution to a 529 plan would require use of the contributor's gift tax credit. Additionally, for older donors, the ability to frontload may not be desirable if they are unlikely to survive the five-year period. In these circumstances, paying the educational expenses directly to the educational institution may be a desirable way to avoid gift tax consequences.
- Donation of Appreciating Assets. Stocks and other appreciating assets may not be contributed to a 529 plan. Where an individual does not want to sell such assets (and realize capital gains) in order to fund a 529 account, an UTMA account or a trust may be preferable alternatives.
- Investment Management. Prepaid tuition plans do not allow for the selection of investments. College savings plans have limited investment options, and account owners are not permitted to switch freely among those options. For individuals who desire greater flexibility with respect to investments, an UTMA account or a trust may be preferable.
- Primary and Secondary Education. The plans may not be used to pay for the expenses of primary or secondary education. To fund primary or secondary education, an individual should consider an UTMA account, a trust or paying these expenses directly to the educational institution.
- Fees and Expenses. Prepaid tuition plans generally charge enrollment and administrative fees. College savings plans may charge enrollment fees, annual maintenance fees, asset management fees and additional broker's fees. Where the avoidance of such fees and expenses is desired, paying the educational expenses may be preferable.
Selected State 529 Plans
All 50 states and the District of Columbia sponsor at least one type of 529 plan. The following are some of the state plans offered.
- District of Columbia. The District of Columbia offers only a college savings plan, the DC College Savings Plan. For more information, see www.dccollegesavings.com.
- Florida. Florida offers two plans: the Florida Prepaid College Plan, a prepaid tuition plan and the Florida College Investment Plan, a college savings plan. For more information, see www.florida529plans.com.
- Maryland. Maryland offers two plans: the Maryland Prepaid College Trust, a prepaid tuition plan and the Maryland College Investment Plan, a college savings plan. For more information, see www.collegesavingsmd.org.
- New Jersey. New Jersey offers two 529 plans: the Franklin Templeton College Savings Plan and the NJBEST 529 College Savings Plan. For more information on the Franklin Templeton College Savings Plan, see www.franklintempleton.com. For more information on the NJBEST plan, see www.njbest.com.
- New York. New York offers two 529 plans: New York's 529 College Savings Program and New Yorks 529 College Savings Program Advisor Plan. For more information on the college savings program, see NY's 529 Disclosure Booklet. For more information on the college savings program advisor plan, see www.columbiafunds.com.
- Pennsylvania. Pennsylvania offers two plans: the Pennsylvania Guaranteed Savings Plan, a prepaid tuition plan, and the Pennsylvania 529 Investment Plan, a college savings plan. For more information, see www.pa529.com/.
- Virginia. Virginia offers four 529 plans, including the Virginia Prepaid Education Program (VPEP), a prepaid tuition plan, and three college savings plans: the Virginia Education Savings Trust (VEST), CollegeAmerica and CollegeWealth. For more information, see www.virginia529.com.
Information on other state 529 plans may be found at www.collegesavings.org among other informational websites.
Elizabeth Carrott Minnigh is an associate with the law firm of Buchanan Ingersoll & Rooney PC and practices in the firm's Washington, D.C., office. She is a member of the Estate Planning and Exempt Organizations Groups in the firm's Tax Section and concentrates her practice on estate planning, charitable organizations and business succession planning. She can be reached at 202-452-6048 or by email at firstname.lastname@example.org.
For more information on our Tax Services Group, contact Tax Group Chair Bruce I. Booken at 412-562-8839 or by email at email@example.com.
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