Using 529 Education Plans as an Estate Planning Tool

As you may be aware, 529 Plans offer families a tax-advantaged way to save for education.

Money that goes into a 529 Plan grows on a tax-advantaged basis & then the money will be distributed tax-free if used for qualifying educational purposes (room and board, tuition, books, supplies, required fees, computer-related expenses etc.)

Depending on what state you live in, you may also receive a state income tax deduction for your contributions. (In New York, you can deduct up to $10,000 of your contributions on your NY state return, if married filing jointly. California, alternatively, doesn’t offer a state deduction and Florida, for instance, doesn’t have state income tax so the point is moot. Again, each state has it’s own rules around deductions, what plan you have to use to receive the deduction, reciprocity agreements with other states etc.)

Ok, so those are the basics.

But 529 Plans can also serve as an effective estate planning strategy as well. I will use my own family to illustrate. When my sister and I were born, my dad set up a 529 Plan for each of us and contributed each year. My parents ended up not needing to use the 529 Plans when Gabby and I went to school and as a result, the 529 Plans continued growing tax deferred during our college years.

Here’s the cool part.

Last year my sister & her husband had a baby boy and so my dad changed ownership of the 529 Plan: he made my sister the owner of the account (rather than himself) and he made his grandson (my sister’s baby), the beneficiary. Now she gets 18+ more years of growth, my dad moved an asset income-tax & gift-tax free to his family, and that 529 Plan can continue to serve as a flexible savings plan for any number of future Drucker children.

A few other interesting/relevant 529 facts:

• You can change the beneficiary on a 529 Plan to a family member at your discretion. So, the 529 Plan may be meant for your daughter Amanda but, let’s say, she ends up getting a soccer scholarship that covers 100% of tuition. You can change the beneficiary on Amanda’s 529 Plan to your son Jack’s name (whose set to go to school in 3 years) without any tax/penalty impact.
• The recent congressional retirement bill created a rule that you are allowed to roll over a portion of your future 529 savings into a Roth IRA so that the funds can be used for retirement as well as education. Click here to read our summary highlights of that entire bill and what it means for your tax & retirement planning.
• 529 Plan balances can be used for private school, trade schools, and (because of the SECURE Act), paying off up to $10,000 of student loan debt per beneficiary. These facts, when combined with the fact that you can change the beneficiary when you want, and the rising costs of education more broadly, mean that 529 savings vehicles are WAY more flexible than previously thought.
• In the absolute worst-case version of this, where you have to take non-qualified distributions (aka not for education) from a 529 plan, you will pay a 10% on the earnings and ordinary incomes taxes. A 10% penalty may sound like a lot, but remember this penalty only applies to the earnings you’ve made in the account and NOT to the contributions. So, if you’ve put $50k into your 529 plan over the last 10 years, and it’s currently worth $70,000, then the 10% penalty only applies to the $20,000 of growth and so your total penalty is $2,000. Manageable. The income taxes are even less of a concern…You would be paying those taxes upon distribution if you contributed that money to a 401k anyway.

Ok guys, I hope this helps start some conversations in your house around education planning…As always, we’re always here to chat if you want to dive into education funding as part of your broader financial outlook!

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