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Those 529 college savings plans can be a flexible way to transfer wealth

June 15, 2021

by Kate Dore

Many consider 529 college savings plans to be for education, but these accounts also offer a flexible way to transfer wealth.

There’s currently an estate tax exemption of $11.7 million per person. Although President Joe Biden campaigned on slashing the write-off to $3.5 million, it hasn’t been part of his agenda.

Regardless of what Biden proposes, the Trump-era tax break will sunset by the end of 2025, restoring the per-person limit to $5.49 million. These changes may expose more families to estate taxes.

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One solution may be gifting more money through 529 college savings plans.

“It’s a very underutilized revocable wealth transfer tool,” said certified financial planner Philip Herzberg, client advisor at The Lubitz Financial Group in Miami.

The benefits of 529 plans

While there isn’t a federal deduction for contributions, 529 plans have some incredible tax advantages, said Mari Adam, a Boca Raton, Florida-based CFP and senior wealth advisor at Mercer Advisors.

Families may use 529 plans to invest and grow money tax-free for approved education expenses, including college or vocational school tuition.

They may also spend up to $10,000 per year for elementary, middle or high school tuition, and there’s a lifetime allowance of $10,000 for student loan payments.

There may also be a tax break at the state level, depending on the plan.

If the child doesn’t need the funds for education, families may change the beneficiary to someone else in the same generation, Herzberg said.

For example, the new 529 plan recipient may be a sibling, niece or nephew.

In a worst-case scenario, someone may overfund the plan and use the money for non-qualified expenses. In that case, they may owe income taxes on the account growth, plus a 10% penalty.

There may also be a state-level levy, depending on the plan.

Despite that, the money has still grown tax-deferred for years, “which is quite a big deal,” said Adam.

Families may reduce the tax bill if their child withdraws the money and reports the income and penalty on their own tax return, she said.

Of course, this assumes their child is in a lower income tax bracket.

“There’s hardly any downside,” she added.

Transfer wealth with 529 plans

With the threat of higher taxes looming, some families may be eager to shift wealth to younger generations.

Grandparents may use a 529 plan for their grandchildren and possibly generations after that, said Herzberg. But there’s one problem: gift taxes.

Wealthy donors often worry about gift taxes, a levy on certain transfers of more than $15,000 per recipient per year. If they gift more than their lifetime limit, they will owe gift taxes on the transfer.

However, there’s an exception for 529 plans, Herzberg said.

Donors may front-load $15,000 contributions for five years by adding $75,000 at once, and they may double their transfer to $150,000 if their spouse agrees to make the same gift.

Donors may use this strategy for multiple recipients, without the risk of gift taxes.

“This is a great way to get grandparents to start making gifts to younger generations and transferring their wealth in a way that really matters,” said Adam.

And unlike some other estate-planning tools, donors may take the money back if they need it, said Herzberg.

These perks may allow families to reduce their estate while paying for education for generations to come, he said.

“This is something that should be in the back pocket of every professional advisor,” said Herzberg.

Investment advisory services are offered through Dynamic Advisor Solutions, LLC, dba Dynamic Wealth Advisors, an SEC registered investment advisor.