529 Plans

By Adil Daudi, Esq. 

A major focus of many estate plans is reducing federal estate tax liability.  Currently, the federal estate tax imposes a 35% tax on any estate exceeding $5 million, or $10 million for married couples.  For example, if you are a single person and your estate is worth $6 million, $1 million of your estate is taxed at 35%.  Instead of your chosen beneficiaries enjoying the fruits of your labor, the government will enjoy $350,000 of your hard earned money.  This exemption amount may not be a problem now; however, many speculate that the limit will be reduced in the next few years from $5 million down to $1 million, causing many savvy individuals to plan ahead. 

How do you reduce the amount of your estate?

Fortunately, many tools exist for reducing the size of your estate.  One such tool is a 529 plan.  A 529 plan is a college savings plan that not only reduces the amount of your estate that will be subject to the federal estate tax but also provides a means of financing your children’s (or grandchildren’s) education. 

How do 529 plans work?

A 529 plan is an investment option whereby the funds that you place into the plan grow tax free and are managed by brokers and other investment professionals.  More importantly for estate tax purposes, a 529 plan can be frontloaded, i.e. five years’ worth of tax free gifts ($13,000 x 5 = $65,000) can be immediately placed into the plan without tax consequences.  However, if you frontload your plan, you may not put in anymore money (that will be tax deferred) for five years.  But because you are able to put $65,000 into the plan right away, waiting five years is rarely a problematic issue.  

529 plans are created for a limited purpose (i.e. college savings) and, as such, the plan’s funds may be used only for limited purposes (without being subject to tax consequences):  qualified educational expenses, such as tuition and room and board.  If you create a 529 plan for your child and they decide that college is not in their future, you may change the beneficiary (the person who is to benefit from creation of the plan) or you can withdrawal the money but you’ll have to pay taxes on the amount withdrawn.   The person who puts money into the plan controls the plan and may choose which state in which to create the plan—you do not have to live in the state where the plan is created. 

How is the amount of the plan removed from your estate?

The amount of the plan is removed from your estate when you place the 529 plan into a trust.  After placing the plan into the trust, for estate tax purposes, the amount of the plan is considered outside of your estate; even though the creator of the plan controls beneficiary designation and has the power to withdraw the funds.  Therefore, you’ll want to contribute as much as you can to these plans.  The higher the plan, the lower your estate tax liability and the more financially secure the future of your beneficiaries.  Plus, in this day in age, if you are going to succeed in this world, education is almost always necessary.  Create a 529 plan today for the well-being of your children tomorrow. 

Adil Daudi is an Attorney at Joseph, Kroll & Yagalla, P.C., focusing primarily on Asset Protection for Physicians, Physician Contracts, Estate Planning, Business Litigation, Corporate Formations, and Family Law. He can be contacted for any questions related to this article or other areas of law at adil@josephlaw.net or (517) 381-2663.

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