It was shortly after the birth of one of my nephews that my sister took me aside and commented sadly that she had just read an article on the cost of college education which gave her pause: “It says we have to save four hundred dollars a month, starting right now, and we should have enough to send him to an average college when it is time. Eighteen years of savings for four years of average college!” She looked close to tears and, of course, with the bills from the hospital and setting up the baby rooms, the plan did not begin until several years later.
But when it did she quickly discovered that there are various governmental programs designed to make saving for that ultimate expense a bit easier and some of them have definite estate tax benefits. The reader should first review our article on Wills and Trusts to understand the basics of estate planning and the estate tax.
If one creates the right type of savings program, one obtains not only income tax benefits but can avoid estate tax on the funds placed in the special account, labeled a “529 College Saving Plan” based on the Code Section allowing it. But the plan can provide for more than mere college education, as discussed below.
SECTION 529 SAVINGS PLAN FOR EDUCATION
The purpose of a 529 plan is to provide funds for a beneficiary's college education. These plans are a result of the tax bill that was enacted during 2001. Up to $13,000 can be contributed each year to a 529 plan without having to file a gift tax return. Contributions can continue until the account reaches $250,000. If a gift tax return is filed, gifts of more than $13,000 may be made during a calendar year. Note that the life time estate and gift tax exemption would be used up if that was the case, but also note that each person has the thirteen thousand dollar a year exemption so that a typical couple could give up to $26,000 into that fund annually with no estate tax.
What are the income tax benefits? Contributions are not tax deductible, but the income from the investments in the 529 plan is income tax free. When the funds are withdrawn and spent for educational purposes, the withdrawals are also income tax free. That means that the appreciation on the funds you contribute are income tax free for all time. Since at seven percent money doubles in about ten years if invested correctly, this could be savings of tens of thousands of dollars in income tax alone.
What are the estate tax benefits? Funds contributed to a 529 plan are no longer included in the estate of the donor. If the donor has an estate that is subject to the federal estate tax, the amount contributed to the 529 plan would constitute a tax savings of between 40 and 50 percent of the amount contributed. As noted in our various Newsletters, the Estate Tax is in the midst of alteration annually and no one knows what it will be after the year 2010. Nevertheless, it is likely that this could amount to a significant savings.
USES OF MONEY
What if the beneficiary decides not to go to college? The donor can change the beneficiary of the plan as often as is needed. However, the new beneficiary must be a member of the previous beneficiary's family, which includes children, grandchildren, brothers, sisters, spouses, nieces, nephews, aunts, uncles, cousins and in-laws. If you are using a trust to create the plan, simply provide that the Trustee has the right to select a beneficiary from among all those people. It would be an odd family, indeed, that did not at least have one of those people willing to go to college if already paid for by the fund! What type of education is included? Post high school education, including undergraduate education, graduate education, and technical training. The expenses that can be paid include tuition, room and board, books, and supplies. Note that by including technical training as appropriate, educational institutions that are not strictly “colleges” may still qualify.
What if the funds have to be withdrawn from the 529 plan for an emergency? The principal that was originally transferred to the account can be withdrawn without penalty. The income that was earned is subject to income taxation and a 10 percent penalty.
To begin a 529 plan you should discuss the matter with your financial advisor, your CPA or your family attorney. There are also web connections with the search word, “529 Savings Plan” but it is still a good idea to integrate the plan into your overall investment and estate planning strategy.