By: Attorney Thomas S. Vercauteren & Law Clerk Sarah E. Schuchardt
529 Plans & Estate Planning: What you need to know
A 529 Plan, named after Section 529 of the Internal Revenue Code, is a college savings program that assists families in saving for a child’s higher education costs. The most common form of 529 plan consists of contributions to an account that is created in order to save for the qualified higher education expenses of a designated beneficiary. The assets of the account are invested by its custodian and any growth in the account is tax-free provided that distributions are used for qualified tuition expenses. Wisconsin currently offers two 529 plans – Edvest, which is sold directly to individuals, and Tomorrow’s Scholar, which is sold through financial advisors. You are not limited to investing in your home state’s 529 plan, but many states, including Wisconsin, offer a state income tax deduction for doing so.
How is the account treated for State and Federal tax purposes?
For 2017, Wisconsin offers a reduction in a Wisconsin adult’s “state-taxable income, dollar-for-dollar, up to $3,140 per beneficiary per year.” This deduction is for all contributors to the account, regardless of the relationship to the beneficiary. The maximum 529 Account Balance allowed in Wisconsin is $456,000 per beneficiary (increased as of February 2017). Parents, grandparents, relatives, trusts, and guardians can open an account on behalf of a child, as long as the party opening the account is 18 years or older. While there is no federal tax deduction for contributions to a 529 plan, the earnings on the contributions grow federal tax-free and are not taxed when distributions are made for qualified tuition expenses. Additionally, a distribution from a 529 plan on behalf of the beneficiary is not treated as a taxable gift unless there is a transfer to a new beneficiary who is not a member of the same family.
A contribution to a 529 plan is treated as a gift to the named beneficiary for the purposes of gift tax and generation skipping tax. However, the gift does qualify for the annual exclusion. This means that for 2017, a contribution of up to $14,000 can be made for any one beneficiary without triggering the need to file a gift tax return and use some of the donor’s lifetime exclusion. Additionally, a donor can make a lump sum contribution and elect to treat it as though it occurred over a period of 5 years. This would permit a donor to make a $70,000 up front contribution in 2017, and then use their annual exclusion over the next 5 years to ensure that no lifetime exclusion is used.
What happens to the account if the account creator or beneficiary dies?
Although it is a completed gift for annual exclusion purposes, the 529 Plan is not includible in the gross estate of its beneficiary or owner (unless they die prior to covering their upfront contribution, see below). If the beneficiary dies, the owner can name a new beneficiary for the account without triggering tax implications as long as it is an eligible family member of the previous beneficiary. See next question for more details on who qualifies as an eligible family member.
If an account donor makes the election to have their upfront contribution distributed over a five year period and dies before the end of that period, then the gross estate of the donor will include that portion of the contributions that are allocable to the periods after the death of the donor.
How do you change an account beneficiary? What are the consequences?
Changing a 529 account beneficiary is quite simple – simply fill out a change of beneficiary form and submit it to your 529 plan administrator. If the new beneficiary is a family member of the previous beneficiary and is assigned to the same generation as (or a higher generation than) the previous beneficiary, penalties and taxes typically imposed on such a change are avoided. However, if the new beneficiary is not related to the previous beneficiary or is not part of the same generation or higher, then the transaction may be subject to gift and/or generation skipping taxes. It is also possible to do a partial change of beneficiary if the original beneficiary will not need all of the funds in the account.
How do you change the account owner?
Changing the account owner is administratively pretty simple: a Change of Plan Owner/Beneficiary form will need to be submitted and the new owner must be eligible to be the new account owner. Changing the account owner essentially opens a new account for the beneficiary with the new owner. You can even designate your child as the successor account owner, but there may be considerable benefits when applying for financial aid to saving the funds in the parent’s name instead of the child.
Many accounts allow for a successor account owner to be named. However, some states only allow the account owner to be changed if the account owner dies or under special circumstances, such as divorce. Wisconsin’s Edvest plan allows the account owner to be changed as long as the individual or entity is eligible. However, there may be income or gift tax consequences as a result. It is important to check with the plan administrator before making any changes.
Are there any penalties for using the funds for non-education related expenses?
Qualified higher education expenses include tuition, fees, books, supplies, and equipment required at an eligible educational institution; expenses for special needs services incurred in connection with enrollment; and expenses for purchasing a computer or peripheral equipment, computer software, or Internet access if used primarily by the beneficiary while the beneficiary is enrolled. If the funds are used for things other than these qualified expenses, then that portion attributable to the earnings on the distribution will be subject to tax as well as a 10% penalty
A 529 Plan can be a great option for preparing for the costs of a child’s higher education. If you have additional questions regarding the interaction between 529 Plans and estate planning, please contact Attorney Thomas S. Vercauteren at firstname.lastname@example.org or (608) 257-0945.