Carnegie Investment Counsel Blog

529 Savings Plans: Can They Be a Wealth Transfer Tool?

Posted by Gary Wagner on Nov 30, 2021 1:30:00 PM

529 Savings Plan Nov Blog

Education savings plans were originally created in the 1980s by various states as a way for students to attain the financial means required for a college education. These plans are still implemented at a state level and are either prepaid tuition or tax-advantaged savings accounts that can be applied to qualified education expenses. 

According to the National Association of State Treasurers, more than 12 million families have saved more than $258 billion in these plans over the last 40 years.

While the primary purpose of these accounts has always been to make a college education feasible from a financial standpoint, they should also be considered a valuable estate planning tool. In light of the current tax treatment of these accounts, they may provide a flexible means for parents, grandparents or other family members to transfer assets to a younger generation.

 

Timeline for State 529 Plans

Beginning in 1986, a number of states like Michigan and Ohio began to offer programs to assist students and their families save for a college education. These accounts eventually became known as Section 529 Plans, in reference to their IRS designation. 

With tuition costs accelerating, various state governments have implemented these plans as federal tuition assistance shifted from monetary grants to guaranteed student loans.

After several court cases and through federal legislation enacted in 1996, the IRS created Section 529 of the Internal Revenue Code, which formally acknowledged state tax benefits on the plans. For the first time, the tax code also allowed for tax-deferred treatment of the earnings when used for education purposes.

Congress further cemented the viability of these plans by passing the Economic Growth and Tax Relief Reconciliation Act in 2001, which fully exempted the earnings of 529 plans from federal taxation. (Learn more about the history of 529 plans here)

According to the Investment Company Institute and The College Savings Plans Network, assets in 529 plans grew from $64.7 billion in 2004 to $373.5 billion by the second quarter of 2020.

 

529 Plan Basics

All states and the District of Columbia now have some form of a 529 plan in place and consumers are not necessarily limited to the plan in their home state. Investment options, potential returns, fee structures and tax treatment vary by state.

Generally, there are two kinds of plans available:

  1. Prepaid tuition plans that permit donors to fix future tuition prices at a cheaper cost today. These plans tend to be more restrictive and are currently offered in fewer than 10 states. The plans likely entail residency requirements. Limitations include attendance at an in-state institution, and non-tuition expenses are not included. The upside here is that these plans effectively guarantee that the value of the account will keep pace with tuition inflation.
  2. Savings plans that allow donors to invest funds on an after-tax basis, comparable to a Roth IRA. Investment options and the accompanying risk parameters vary widely by state. The account value appreciates tax-deferred and no additional federal taxes are due at withdrawal time if used for qualified expenses. Additionally, many states offer tax deductibility on state income tax for new contributions. The vast majority of assets currently held in 529 plans are in this type of account.

 

How 529 Accounts Can Be an Effective Wealth Management Tool

Reducing the size of their taxable estate is an important objective for many higher net-worth families. 529 accounts can be an effective means to accomplish this goal. The following tax rules that apply to these accounts make this possible.

All contributions may be made regardless of the income level of either the donor or beneficiary. Two important tax considerations when contemplating opening a 529 (first state, then federal) are:

  1. Every state has a total contribution limit for each 529 plan, from a low of $235,000 (Georgia) to a high of $529,000 (California). These caps consider possible undergraduate and graduate school tuition along with room and board plus other related expenses.
  2. There are no annual contribution limits to 529 accounts for federal tax purposes, but contributions that exceed the annual gift tax exclusion are tabulated as part of the individual lifetime estate and gift tax exemption. For the tax year 2021 the gift tax exclusion is $15,000 and the lifetime exemption is $11.7 million. 

So, an individual can gift $15,000 per child, per year without paying federal tax and the account will grow without federal tax implications if used for school expenses.

For those seeking to make larger one-time contributions, it is possible to spread the tax treatment of the donation over a period of five years. For example, a donor may retain their maximum annual gift tax exclusion with a lump-sum contribution of $75,000 that is applied as $15,000 per tax year. If the taxpayer's spouse agrees to the same gift amount, then $150,000 may be gifted without triggering any negative consequences from a tax standpoint.

 

Limits to 529 Accounts

Since 529 accounts were established with a college education in mind, there may be concerns about the consequences if the beneficiary chooses not to attend college. Use of the funds outside of qualifying expenses will trigger an adverse tax event and penalty. However, there is greater flexibility today than in the past if this occurs. Some options:

  1. Transfer the account to another qualifying family member
  2. Use up to $10,000 withdrawal for K-12 tuition per student per year
  3. Repay up to $10,000 in student loans per borrower for both the beneficiary and the beneficiary’s siblings
  4. Use the funds to further the donor’s own education
  5. Rollover the funds to a 529 ABLE account, for people living with disabilities

 

Conclusions

Many high net-worth taxpayers are concerned about potential changes to the IRS code in the next few years. The $11.7 million estate tax exemption mentioned above is not set in stone.  

The 2017 tax overhaul that raised the exemption from $5.6 million to the current level will sunset in 2025, absent any additional action by Congress.

Section 529 plans have been a great success story for many Americans seeking to invest in the future of their children and grandchildren. In light of the current estate tax treatment of these accounts, careful consideration should be given when the time comes to review estate plans with a financial advisor.

 

References and More Information

CollegeSavings.Com: History of 529 Plans: https://www.collegesavings.org/history-of-529-plans/

Investment Company Institute: 529 Plan Program Statistics: https://www.ici.org/research/stats/529s/529s_20_q2

SEC.gov: An Introduction to 529 Plans:

https://www.sec.gov/reportspubs/investor-publications/investorpubsintro529htm.html

IRS.gov: Publication 526 (2020), Charitable Contributions:  https://www.irs.gov/publications/p526

 

Disclosure: The information provided is for general educational purposes only and should not be considered legal or investment advice. Although the information has been obtained from sources believed to be accurate as of the date of original publication of this article, the information is subject to change over time, and Carnegie does not guarantee the accuracy of information obtained from third parties.

 

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Topics: Financial Planning, Investment Management, Wealth Management

Gary Wagner

Written by Gary Wagner

Gary Wagner is Principal and Chief Operations Officer. He also works directly with clients to provide investment and strategic wealth advice. Gary sits on Carnegie’s Investment Committee and also manages the firm’s strategic initiatives and operations.

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