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These plans can offer a variety of potential benefits that go beyond their traditional role.
For affluent parents and grandparents, 529 plans are synonymous with college planning, but they can offer a variety of potential benefits that go beyond their traditional role. In fact, a 529 plan can be a worthwhile estate planning tool for physicians looking to reduce the size of their taxable estate while maintaining control of their assets.
529s are first and foremost a college savings tool. College savings plans come in two forms: prepaid college tuition plans or 529 savings plans. The former allows you to lock in today’s tuition rates, while the latter allows you to choose from a selection of investment choices depending on your personal preference. 529 savings plans are state sponsored but administered by one or more investment companies. Keep in mind, you aren’t limited to the plans in your home state. You can participate in national plans sponsored by other states as well. When making this choice, check into any tax advantages your state may offer if you utilize the 529 plan sponsored by your home state.
There are a number of benefits that make 529 plans appealing, but the most popular perks include:
Withdrawals that do not fall under the IRS’s definition of "qualified education expenses" are subject to ordinary federal and state income taxes and may be subject to a 10% additional federal tax penalty unless a specified exception applies.
It’s clear to see why 529s are often the preferred method for college savings, but how about the role they can play in limiting estate taxes? What’s little known to many investors is how 529s can support a long-term gifting strategy that allows donors to maintain control over the assets while also removing them from their taxable estate.
Here’s how it works.
Parents and grandparents, then, can make scheduled gifts up to the tax-free limit each year, gifting $15,000 to each grandchild (and/or great grandchild) on an annual basis.
But what if you need a bigger impact on a shorter time frame? Luckily, gifting can be accelerated to accommodate. Individuals can elect to make a lump-sum contribution of five years’ worth of gifts, or $75,000 in one year, tax-free. Of course, any other gifts made outside the 529 in those five years (to the same individuals) will count toward this allowance, so be sure not to exceed the threshold unless you’re prepared to potentially pay gift taxes on the excess amount.
The wealth transfer potential here is unmatched by virtually any other savings tool available. An individual who has four grandchildren, for example, could immediately remove up to $300,000 from his or her taxable estate by contributing the money to four separate 529 plan accounts. Every five years, this process can be repeated. And if the donor is married, the spouse can follow the same strategy.
Again, it’s worth stressing that the assets gifted into the 529 remain in the control of the accountholder, not the beneficiary. There will be no need to worry about the beneficiary using the funds without your express involvement in or oversight of the withdrawal. The accountholder also can change the beneficiary of the account if desired to any first degree relative of the original beneficiary (e.g., sibling, cousin, etc.) making these very flexible investment vehicles while still remaining outside of the donor’s estate.
Beyond their place in college planning, state-sponsored 529 college savings plans have the potential to double as high-powered estate planning tools for affluent physicians and their families.