Using 529 plans to invest for college and manage wealth

    Q: My partner and I have two young children. We have been putting money away each month into a 529 plan to save for college. We’ve also heard of friends using 529 plans to help lower their estate taxes too. Can you please explain how that works?

    A: I’m very pleased to hear you’re thinking ahead regarding college planning for your children. And your friends are doing some wise planning too. For affluent parents and grandparents, a 529 plan offers a variety of potential benefits — including some that go beyond the scope of college planning. A 529 plan may in fact play an integral role in an estate plan.

    Paying for a child’s or grandchild’s college education is an expensive proposition, even for many high-net-worth Americans. Today’s elite institutions promise graduates a rewarding future, but at a cost that more often than not extends well into six figures. Enter the 529 plan, a tax-advantaged investment vehicle generally available to families regardless of their income level.

    First and foremost, a college savings tool …

    Before you consider the potential role of a 529 plan in your estate plan, it is important to understand a few basics:

    • There are two types of 529 plans: prepaid tuition plans, which let you lock in tomorrow’s tuition at today’s rates; and college savings plans, which let you choose from a menu of investments and offer more return potential, as well as risk. Both types of plans are generally sponsored by a state government and administered by one or more investment companies. (Tax law also permits certain educational institutions to sponsor prepaid tuition plans.)

    • Many 529 plans offer age-based asset-allocation portfolios that become more conservative as the beneficiary grows older.1 Others let account owners choose from individual investment options to create a customized portfolio.

    • Originally, 529 plans offered the benefit of tax-deferral — taxes on earnings were not due until withdrawal, and then only at the beneficiary’s rate. But a few years ago, Uncle Sam sweetened the pot, and now qualified withdrawals are federally tax-free.

    • Eligibility to contribute to a 529 plan is not limited by age or income. In addition, total plan contribution limits often exceed $200,000.

    • Withdrawals can be used to pay for undergraduate or graduate school expenses. Withdrawals used for purposes that fall outside of the “qualified education expenses” category are subject to ordinary income taxes and a 10-percent penalty tax.

    … but with valuable wealth-transfer potential

    The IRS clearly had college planning in mind when it drafted Section 529 of the Internal Revenue Code. However, it also left the door open to use 529 plans as wealth-transfer tools. That is because a contribution to a 529 plan is considered a completed gift from the donor to the beneficiary named on the account, even though the account owner, not the beneficiary, maintains control over the money while it is in the account. Tax rules permit you to give $13,000 (indexed to inflation) to as many individuals as you choose each year, free from federal gift taxes. Couples, including same-sex partners, can give $26,000 without incurring taxes. As a result, one method of reducing a taxable estate is to make scheduled gifts up to the tax-free limits each year. For instance, you might give $13,000 to each grandchild on an annual basis.

    But there is more. Under special rules unique to 529 plans, donors looking to remove large sums of money from their taxable estates can make five-years’ worth of $13,000 gifts in one year — that’s $65,000 per individual donor or $130,000 per couple. Of course, you would not be able to make additional taxable gifts to that beneficiary during the five-year period. And if you use the five-year averaging election and die before the five years are up, a prorated portion of the contribution may be considered part of your taxable estate.

    But the wealth-transfer potential can be substantial. For instance, an individual who has five grandchildren could immediately remove up to $325,000 from his or her taxable estate by contributing the money to five separate 529 plan accounts. Five years later, he or she could do it again.

    You stay in control

    It’s worth emphasizing: Although the assets contributed to a 529 plan are no longer considered part of your taxable estate, you still exercise control over the money. You decide how it will be invested — within the confines of the plan’s available investment options — and when it will be withdrawn. You also have the right to change beneficiaries, in the event that the original beneficiary decides not to attend college, for example. And doing so generally will not trigger tax consequences if you choose a beneficiary who is a member of the original beneficiary’s family. (As spelled out in Section 529, qualified family members include the beneficiary’s brothers, sisters, parents, sons, daughters, nieces and nephews, among others.) If there is no other suitable beneficiary, you also have the option of closing the account and taking the money back, although earnings will be subject to income taxes, as well as a 10-percent penalty.

    When choosing a 529 plan, you will need to look beyond estate-planning considerations. There are dozens of plans available and their features and rules can vary greatly. To help narrow the choices, consider working with a qualified financial professional. And be sure to consult with an estate-planning attorney or tax professional before making any decisions that could affect your tax liability.

    Prior to investing in a 529 plan, investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other benefits that are only available for investments in such state’s qualified tuition program. In our local tri-state area, Pennsylvania allows residents a state-tax deduction for contribution into any 529 plan (income limitations apply). New Jersey and Delaware currently offer no such state-tax deductions.2

    Jeremy Gussick is a financial advisor with LPL Financial, the nation’s largest independent broker-dealer.* Jeremy specializes in the financial planning needs of the LGBT community and was recently named a 2011 FIVE STAR Wealth Manager by Philadelphia Magazine.** He is active with several LGBT organizations in the Philadelphia region, including the Delaware Valley Legacy Fund, the Greater Philadelphia Professional Network and the Independence Business Alliance. OutMoney appears monthly. If you have a question for Jeremy, email [email protected] LPL Financial, Member FINRA/SIPC.

    *As reported by Financial Planning magazine, 1996-2012, based on total revenues. **Award details can be found at

    1 Asset allocation does not assure a profit or protect against a loss 2 Source:

    This article was prepared with the assistance of S&P Capital IQ Financial Communications and is not intended to provide specific investment advice or recommendations for any individual. Consult your financial advisor, or Jeremy, if you have any questions.

    Because of the possibility of human or mechanical error by S&P Capital IQ Financial Communications or its sources, neither S&P Capital IQ Financial Communications nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall S&P Capital IQ Financial Communications be liable for any indirect, special or consequential damages in connection with subscribers’ or others’ use of the content.